What Is Bonding in Construction? A Full Guide for Contractors

Construction projects often have tight timelines, large budgets, and several risks. If one thing goes wrong, it affects the entire project, resulting in delays, disputes, and even financial loss. That’s why many clients and project owners won’t work with a contracting business unless they’re properly bonded. Being bonded shows your client that you’re a responsible contractor who takes legal and financial obligations seriously.

In this guide, we’ll explain in simple terms what bonding in construction means, why it’s required, how it works, and how to secure surety bonds in Canada.

What Is Bonding in Construction?

Bonding in construction is a legal and financial guarantee that protects project owners from financial losses if the contractor fails to meet their obligations. The three parties involved in this agreement are:

• The principal (the contractor or contracting business)
• The obligee (the project owner)
• The surety (the surety company that issues the bond)

If the contractor doesn’t deliver the project as agreed, whether due to poor workmanship or delays, the surety compensates the client or arranges for the project’s completion. Besides providing financial security to project owners and clients, surety bonds also enhance the contractor’s credibility, reputation, and chances of winning bids and securing new projects.

How Construction Bonds Work?

A construction bond is a three-party agreement that works as a financial guarantee by protecting the project owner from financial loss if the contractor fails to meet the terms of the contract. This can be incomplete work, missed deadlines, substandard materials, or defective construction. If the contractor defaults on their obligations, the bond issuer (also known as the surety company) steps in to fix the issue. However, it’s not free money, and the contractor will still be responsible for repaying the surety company for any costs paid to the client or project owner.

Who Are the Parties Involved in a Construction Bond?

• Principal: The contractor or the business that has signed a construction contract for a project, and is responsible for completing the work according to the agreed terms.
• Obligee: The project owner or government agency that requires the construction bond before agreeing to work with the contractor. If the contractor defaults on their contractual obligations, the obligee can file a claim with the surety to compensate for the damage or arrange to complete the project.
• Surety: The bonding company responsible for issuing the construction bond. If something goes wrong on the contractor’s side, the surety will protect the project owner from any financial loss caused by missed deadlines, unfinished work, or defective construction. The contractor remains responsible for paying the surety back for any claims covered.

What Are the Requirements for Construction Bonds?

To be able to secure construction bonds in Canada, contractors need to meet specific criteria set by the construction bonding company. These requirements help insurance companies assess the contractor’s financial situation and operational strength to determine their eligibility to take on bonded projects and their bonding capacity.

Below are the main requirements:

• Solid Financial Statements: Surety bonding companies review credit score and bank statements to ensure that the contractor has the resources to complete the project as agreed.
• Work Experience: A successful history of similar completed projects is necessary to show how reliable and professional the contractor is before providing bonds to them.
• Clean Legal Record: Contractors must show good credit standing and no unresolved legal disputes, liens, or past bond claims.
• Signed Indemnity Agreement: Before buying surety bonds, the contractor must sign an indemnity agreement stating that they will reimburse the surety for any claim that’s paid on their behalf.
• Bonding Fees: Contractors must pay a premium for the bond, usually ranging from 0.5% to 3% of the total project value.

Who Needs a Construction Bond?

Contractors bidding on government projects or private projects need construction bonding to enhance their chances of winning contracts and meeting clients’ requirements. Contractor bonding might even be mandatory in some cases, especially in large public projects.

Here’s who needs a construction bond:

• General Contractors
• Subcontractors
• Commercial Builders
• Speciality Trades

Whether you’re working on a small project or a full-scale construction job, many clients won’t sign a deal with you unless you’re bonded. In both the public and private sectors, construction bonds give contractors a competitive edge and enhance their chances of winning bids.

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What Does a Construction Bond Cover and Not Cover?

Construction bonds provide financial security to project owners by guaranteeing that the contractor will meet the terms of the agreement. There are several types of construction bonds, but generally, they are designed to protect against financial loss if the contractor fails to finish the project, deliver quality work, or pay suppliers and subcontractors.

However, construction bonds don’t cover design errors, changes to the scope of work, wear and tear, or costs that exceed the bond amount. These issues require a different type of protection, such as insurance or maintenance agreements.

What Are the Different Types of Construction Bonds?

The main types of construction bonds in Canada are:

Bid Bonds

Bid bonds guarantee that if you’re awarded the project, you’ll honour your bid, sign the contract, and complete the job as agreed. If you back out, the surety will step in and cover the difference between your original bid and the next lowest bidder up to the bond amount. You’ll be responsible for paying the surety back for any claims covered.

Performance Bonds

Performance bonds protect project owners from shoddy work that doesn’t meet the contract requirements. They also assure the project owner that you’ll finish the job as agreed and in a timely manner. If the contractor fails to deliver, either by abandoning the project or falling behind schedule, the surety may step in to pay for the project’s completion or hire another contractor.

Labour and Material Payment Bonds

Payment bonds ensure that the general contractor will pay any parties involved in the construction project, including subcontractors, suppliers, and labourers. If you don’t pay these parties for their work or materials, they can file a claim against the bond so that the surety can reimburse them.

Maintenance Bonds

Maintenance bonds, or warranty bonds, ensure that you’ll fix any workmanship defects that arise after the project’s completion. These bonds are usually valid for 1 to 2 years and are mostly required for public projects or large projects.

Mechanics Lien Bonds

This contractor bond is used when someone puts a lien on a property because you haven’t paid them for work or materials. This bond removes the lien so the project or property sale can move forward. If the claim is valid, the surety will cover the payment, and you’ll pay the bonding company back.

Subdivision Bonds

If you’re working on a construction project that involves public improvements like sidewalk maintenance or electrical upgrades, you might be required to carry a subdivision bond. This bond guarantees that you’ll complete the required public infrastructure according to city or town standards.

Supply Bonds

Although most contract surety bonds are provided by the general contractor, supply bonds are provided by suppliers. This bond guarantees that the supplier will provide the necessary building supplies, and if they default, the project owner can file a claim to recover the cost of replacements or delays.

Retention Bonds

A retention bond works as a guarantee for the project owner to ensure that any defects or flawed work will be addressed without the need to hold back a portion of the contractor’s payment. Instead of withholding funds until the end of the maintenance period, the project owner accepts the retention bond to secure his money.

How Much Does a Construction Bond Cost?

The cost of a construction surety bond usually ranges between 0.5% and 3% of the total project value. However, the cost can be as high as 5% of the project value for contractors with limited experience or a poor credit score. When calculating your bond premiums, bonding companies consider several factors, including:

• Credit Score & Financial Statements
• Your Work Experience
• Project Size and Type
• Bond Type

How Construction Bond Costs Are Calculated

To calculate the cost of a construction bond, use this formula:

Bond Cost = Contract Value × Bond Rate (%)

For example, if you’re bidding on a project with a contract value of $500,000, and the bonding company offers you a rate of 1%, the contract bond cost will be: $500,000 x 1% = $5,000

If you want to buy multiple bonds, you can use the same formula for each single bond, then calculate the total by adding the cost of each one. You can also contact our surety broker to get an accurate quote based on your specific project details and credit profile.

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What Is Bonding in Construction – FAQs

What is bonding used for in construction?

Bonding in the construction industry is used to protect project owners from financial loss if a contractor fails to meet their obligations. Bonding is also a requirement in many projects, and it’s especially mandated by local governments for public projects.

What does bonding do for a contractor?

Bonding is important for project owners, but it’s also essential for contractors because it enhances credibility, trust, and access to larger opportunities. A construction bond shows that the contractor is financially stable, reliable, and committed to completing the project according to the contract terms.

What is the most common bond in construction?

Performance and payment bonds are the most common types of bonds used in the construction industry. These bonds are required in both public and private projects to protect the project owner, the subcontractors, and the suppliers involved in the project.

What is another name for a construction bond?

Another name for construction bonds is contract surety bonds. These bonds are used in the bidding process to show that a contractor is reliable and financially capable of completing a project.

How much does a construction completion bond cost?

The cost of a construction completion bond ranges from 0.5% to 3% of the total project value. Investing in a completion bond helps contractors stay ahead by making them eligible for more competitive bids and public projects.