Contractor bond illustration with money and photo of contractor in ditch on construction site

Construction is one of the most highly regulated industries, and there are tons of requirements that contractors must meet. One such requirement is securing a contractor bond, which many states, counties, and cities require in order to obtain a license. But what is a contractor bond, and how does it work? Let’s find out.

What is a contractor bond?

A contractor bond is a legally binding agreement between three parties. Those three parties include the contractor securing the bond (called the principal), the agency requiring the bond (called the obligee), and the surety supplying the bond.

It essentially guarantees that the contractor will perform in a prescribed manner (according to the law), or the surety will pay the agency or public for damages.

Who requires a contractor bond?

State and local licensing agencies typically have a lot of requirements, including certain insurances and bonding. For example, most states require contractor license applicants to carry workers’ compensation insurance, liability insurance, and a contractor bond. 

For example, the Alabama Board of Heating, Ventilation, Air Conditioning, and Refrigeration Contractors requires applicants to secure a $15,000 contractor license bond. The Oregon Construction Contractor’s Board requires residential GCs to secure $20,000 bonds and specialty subcontractors to secure $15,000 bonds. 

Local jurisdictions which require their own licensing or permits might also have bond requirements. 

How does a contractor bond work?

While bonds are typically looked at as an insurance policy, they’re more akin to a line of credit. When a contractor applies for the bond, the surety does a background check. It investigates the contractor’s credit score or assets, and then determines how much the contractor needs to pay (usually around 1–2% of the total bond amount).

For that bond amount, the surety guarantees the licensing agency that the contractor has the means to pay for damages. For example, if the licensing agency believes the contractor isn’t operating their business within the parameters of the bond, they can place a claim against the bond

The same goes for the public; if the contractor doesn’t meet the requirements of the contract with a project owner, the project owner can file a claim. These claims are then investigated.

If the claims are found to be legitimate, the surety will pay for damages to the agency or the public. But, unlike an insurance company, the contractor must pay the surety back. So a contractor bond is essentially like having an emergency loan or line of credit at the ready.

Who is protected by a bond?

Initially, who the bond protects might not be clear. A contractor bond’s primary function is to protect the licensing board and the public against the contractor. If the contractor doesn’t abide by the language in the bond, the licensing agency can file a claim against the bond. 

The same applies for the public: If the contractor doesn’t follow the terms of the agreement or contract, clients can file claims against the bond.

In some ways, contractor bonds also protect the contractors. First, every claim against the bond warrants an investigation from the surety to determine its validity. Frivolous or false claims aren’t paid out, meaning the contractor doesn’t have to pay the surety back. Second, should a claim prove to be valid, the contractor doesn’t need to cough up the claimed amount immediately: The surety will foot the bill for a bit. The contractor just has to pay it back. 

What’s the difference between a contractor bond, workers’ compensation, and liability insurance?

Licensing agencies typically have a few requirements that contractors must meet, including:

  • Workers’ compensation protects employees if they suffer an injury on the job. It covers their medical bills for the injuries related to the accident and ensures they continue to receive a paycheck during their recovery.
  • Liability insurance protects the company from suits related to negligence, accidents, and damages that occur during the course of business.
  • Contractor bonds protect licensing agencies and the public against contractors operating outside the terms of the bond.

For more information on the other types of bonds, check out this construction bond guide

How do you get a contractor bond?

Getting a contractor bond isn’t tricky, and it’s really not very expensive. As far as state licensing requirements go, it’s one of the easiest to abide by. The following are the basic steps:

Determine the agency’s requirements

Every agency’s requirements are different, so you need to know which apply to you and your license type. For instance, general contractors will typically have larger bond requirements than subcontractors, as they’re responsible for the overall project and prime contract. Also, electrical and plumbing contractor amounts might be different from a fire sprinkler contractor.

Keep in mind that contractors possessing more than one license might need to carry separate contractor bonds for each license type. It’s also a good idea to check with the individual cities you plan to work in, as their bond requirements might be higher than the state’s. 

Check out this Ultimate Guide to Licensing in Every State for more information about the requirements in your state.

Find a surety and apply

Once you have a good grasp on the type of contractor bond you need, you need to find a surety that offers contractor bonds. A Google search is a good start, but be sure to check reviews from other contractors who have experience with the surety. 

When you apply, have your business and personal financials available for the surety to review. They’ll look at your credit score, net worth, and other indicators of your creditworthiness before making a determination. 

Pay for the bond

After the surety has a chance to review your financials, it will determine how much you’ll need to pay for the bond. In general, contractor bonds are 1 to 2% of the bond total. So, for a contractor with excellent credit, a $20,000 bond might cost $200. Some sureties even offer payment plans, allowing contractors to spread out the cost of their bond over a few months. 

Send the bond to the issuing agency

With the application and payment out of the way, you need to send proof of the bond to the state. Some states might require proof of the contractor bond along with the application, while other states might give applicants a certain amount of time before they need to send it in.

If you’ve met all the other criteria for licensing, the issuing agency will accept your proof of bond and issue a license to you. And, while you’re protected with an emergency line of credit, be sure to operate to the best of your ability so you never need to use it. 

Bonds can be important to licensing

Remember, contractor bonds can be an essential part of the licensing process — and contracting without a license or while improperly licensed is definitely a bad idea. Make sure to check the contractor license bond requirements in the state, county, and city you’re planning to work in.

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