The contractor licensing process can be very intimidating.
For many, Navigating and understanding construction laws is a very daunting task.
Furthermore, California is notorious for having more laws than other states. One of the most common areas of confusion is construction bonds.
A simple search on google brings up several different types of bonds. This course will cover Surety Bonds, Performance Bonds, Construction Bonds, and Payment Bonds.
How do you know which one is right for your construction business?
The following information breaks it all down in detail clearly so that you can make an informed decision.
First, let's get into how construction bonds work:
What Is A Construction Bond?
- A construction bond is a security deposit issued by a surety company.
- Bonds are designed to protect the consumer public against contractor default.
- Construction bonds act as protection mechanisms for clients from unethical or illegal actions performed by contractors.
- Construction bonds also ensure that subcontractors get paid for their work. They also ensure or that a contractor performs his duties as stated in a contract.
- Construction bonds protect employees, suppliers, sub-contractors or clients against a contractor's failure to abide by an agreement.
Surety Bonds, Performance Bonds, Payment Bonds, Construction Bonds… What is the difference?
Surety Bonds
- In the construction world, “surety bond” is an umbrella term for various types of bonds.
- Likewise, a surety bond is a promise from a guarantor to pay one party a stipulated amount if the second party fails to meet an obligations of a contract.
- Surety companies licensed by the state to sell insurance products issue construction bonds.
Performance Bonds
- A performance bond may require additional stipulations or terms of completion as part of the bond.
- For example, a contractor may be required to hold a performance bond before being able to accept a public works project due to the fact that tax payer funds are involved.
- Public agencies typically prefer contractors that hold performance bonds to protect themselves against contractor default
- Often subcontractors hold performance bonds, to ensure that they complete work as specified in the contract.
- In California Prime contractors are responsible for work completed by subcontractors
- As a result, most insurance companies require businesses to ensure that the contractor taking on the project has a construction bond.
Payment Bonds
- Payment bonds guarantee that general contractors pay their subcontractors for work completed.
- For example, a roofing subcontractor may ask a general contractor to hold a payment bond before any work is rendered.
- Consequently, a homeowner may also ask that a general contractor has a payment bond in place to protect themselves against a claim from an un paid subcontractor.
Bid Bond
- A bid bond is designed to provide a developer with a guarantee that if a contractor wins a bid he/she must undertake the bid at the terms set.
- Most states issue standard construction bonds, which allow contractors to legally perform work.
- While the bid bond is a less common form of construction bond, their functions are very similar.
Construction Bonds vs Insurance Policies
- The biggest difference between construction bonds and insurance policies is that bonds protect your clients and the consumer public.
- In contrast, Insurance policies protect you and your workers from the consumer public.
- Insurance policies are not required to have an active license while construction bonds are.
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Bonding and your Contractor License
- The state of California, requires you to have a construction bond to maintain an active contractor license.
- A contractor license can sometimes can be extended to another individual but a surety bond can never be transferred to another license holder.
- Each individual needs to have their own bond to maintain an active license. When you pass the state license exam, you must provide your bond number to activate the license.
- The bond amount must be paid annually for the bond to remain active.
What Is a Disciplinary Bond?
- You may be required to post a disciplinary bond with the CSLB if at any point; your license is revoked, a claim is placed against your construction bond or you were found to be in violation of California Contractor Law.
- The amount that you will have to pay depends on the seriousness of the violation.
Claims against Surety Bond
- If a claim is filed against your construction bond, the matter is investigated by the surety company issuing the bond.
- The moment you find out that a claim has been filed against your bond, It is recommended that you contact your surety company immediately.
- Explain in detail your situation and include all copies of contracts and relevant information.
- Furthermore, It is your responsibility to keep organized documented records relevant to the claim.
The best way to avoid a claim against your bond is to always include the terms of a construction contract in writing. Also, include documentation of any changes to the contract that may have occurred before the project was completed.
Keep Clear and Organized Records
- Maintain clear and accurate records of money received and paid. Communication is always key.
- The quicker you communicate potential problems with subcontractors, project managers or homeowners the less likely it will be that they spiral out of control.
- Ending up with a claim on your bond will force you to pay more in order to work legally.
- Remember if a consumer is not satisfied with the payout from your bond, they can take you to small claims court for further reimbursement of damages.
- However you can also do the same, and the more organized your records are, the stronger case your case will be in front of a judge.
Surety Bond Cost
- Prices for construction bonds are determined by several factors.
- Typically, a minimum bond amount is required by your state or county to maintain an active license.
- A license holder can also act as a qualifying individual of a company. This person, known as an RME or RMO may qualify a company and everyone legally associated with the company to perform construction work.
- Acting as an RME or RMO may affect your annual premiums for a construction bond.
- Some Bond companies offer first year flat rate fees for a certain amount of coverage.
- Each year you pay an annual rate based on your credit score.
Alternatives to Construction Bonds
- There are alternatives to bonding, the state of California allows you to file a cash deposit of $15,000 in place of a construction bond.
- Payment must either be in the form of a: bank check, savings account passbook, certificate of deposit, or investment certificate.
- A cash deposit cannot be released until after 3 years of the expiration date of the license period of which it provides coverage.
Where to Purchase Construction Bonds?
- Bonding companies can help you set up a bond quickly and provide you with the number the CSLB will ask you for after passing the exam.
- There are many places to purchase construction bonds, hence doing research prior to calling a surety company is always your best bet when searching for rates.
- Identifying a company you can trust with a great track record of success is key. Lowest price options certainly are not always the best value. Look for a competent company.
- Someone who will be on your side and certainly a company that is familiar with the construction industry.
- Do your homework, furthermore, make sure the surety company you choose prioritizes customer service. You will not want to be stuck on hold when dealing with a client filing a claim against you.
Do your research
Doing your due diligence pays off in the end. You are going into business with the surety company so treat your search almost like a hiring process.
Companies that offer insurance products specific to the construction industry are often better options than ones selling a variety of insurance products.
The name of the game is being organized and transparent in your business, which should go without saying. Above all, keep good records, open communication, and follow through on what you promise.
The majority of issues like claims, complaints, and other disciplinary actions against your license and bond, can easily be avoided with simple attention to detail.