If you are a contractor and think surety bonds seem like a confusing concept, you are not alone. Even the most seasoned contractors may still have difficulties fully understanding what contract surety really means. Thankfully, contract surety and surety bonds are actually quite simple when you break them down. Contract surety, in particular, plays an important role in the construction industry. It ensures that things go as planned and that everyone involved in a project receives their promised outcomes.

For this article, we asked Ferrari Insurance’s Director of Surety, Kari Davis what exactly is a surety bond. According to Kari, we should think of contract surety like a three-way promise or a safety net between three parties:

1. The Principal – This is the person or business doing the work. In most cases, this is a contractor.
2. The Obligee – This is the person or entity that needs the work done. For instance, a government or private owner who wants a building constructed.
3. The Surety – This is the company that provides the financial guarantee that the contractor will fulfill their obligations.

The whole idea of contract surety is to make sure the contractor sticks to their agreement. If the contractor fails, the surety steps in. The surety will get the project back on track or it will compensate the party who is owed. It’s sort of like an insurance policy for the project, but contract surety is not insurance as there are some key differences.

How Does Contract Surety Work?

In simple terms, let’s say a municipal government wants to build a new library. They hire a contractor, but they also want some assurance that the contractor will finish the project on time and to the right standard. But to make sure that happens, they require the contractor to get a surety bond. Now, if the contractor runs into problems—maybe they can’t finish the work or worse, they go out of business—the surety company will step in. This might mean hiring a new contractor to finish the job, or it could mean covering the costs to make things right.

What are the Different Types of Contract Surety Bonds?

There are a few different types of contract surety bonds, and each has a specific purpose. Here are four common types of contract surety bonds:

1. Bid Bond – A Bid Bond guarantees that when a contractor bids on a project, they’ll sign the contract and get the necessary bonds if they win the bid. Think of it as a promise that they’re serious about doing the job.
2. Performance Bond – Performance Bonds ensure the contractor will actually complete the project as agreed. If they don’t, the surety company will step in to either finish the job or pay for the costs of finding someone else to do it.
3. Payment Bond – A Payment Bond guarantees that subcontractors, suppliers, and other workers on the project will get paid. So, if the contractor doesn’t pay them, the surety company will.
4. Maintenance Bonds – Maintenance Bonds are guarantees that the contractor will repair any defects or issues that arise in the workmanship or materials after the project is completed. Maintenance bonds are typically valid for a set period of time. It’s like a warranty, ensuring the project owner that any problems will be fixed without additional cost.

Each of these bonds protects different aspects of the project, but the goal is ultimately the same: to make sure that everything goes smoothly, and if it doesn’t, there’s a plan in place to fix things.

Why Are Surety Bonds Needed?

The truth is, construction projects are risky endeavours. They can take a long time, cost a lot of money, and involve many moving parts. Sometimes contractors hit bumps in the road—like cash flow problems, supply chain delays, or technical issues that can throw a project off course. That’s where contract surety comes in. It’s a way to keep things on track, giving project owners peace of mind that their investment is protected.

Who Pays for a Surety Bond?

The cost of a surety bond typically falls on the contractor. The contractor will pay a small percentage of the total bond amount, which is usually between 1-3%.

For example, if a construction project costs $1,000,000, the contractor would typically pay between $10,000 and $30,000 for the contract surety bond, since the cost is approximately 1-3% of the project total.

In other words, for smaller projects, the cost might be closer to the lower end, while larger, more complex jobs might push the cost toward the higher range.The price they pay depends on a few factors: the size and complexity of the project, the contractor’s credit history, and their track record of completing similar jobs. Contractors who have a good history of finishing projects on time and within budget often pay less.

What Happens When Contracts Go Wrong?

If the contractor doesn’t fulfill their obligations, the obligee (the project owner) makes a claim against the bond. The surety company then investigates the claim to figure out the best way to resolve it. They might cover the financial losses, hire a new contractor, or even help the current contractor get back on track.

However, the surety company doesn’t just take the hit. So, if the contractor is at fault, they’re expected to pay the surety company back for any losses incurred. This is one of the key differences between surety bonds and insurance. With insurance, if something goes wrong, the insurance company absorbs the loss. But with surety bonds, the contractor is ultimately on the hook for making things right.

In short, contract surety is like a safety net for construction projects, protecting project owners from the financial risks of a contractor not living up to their promises. Contract surety keeps things fair, makes sure workers get paid, and ensures projects reach the finish line—even if things go sideways along the way.

To learn more about contract surety, please read our other blogs, visit Surety Canada‘s website, ask for Kari Davis at 1-888-467-8989 or contact Vice President of Construction Insurance, Mike Di Pinto at 647-824-8410.

*The information provided on this page is for information purposes only and should not be taken as insurance advice. For actual insurance advice, please contact Ferrari & Associates at 1-888-467-8989