Danielle Rodabaugh, Surety Bonds Insider
The understanding most contractors have of surety bond legalities typically doesn't go much further than the fact that they have to buy bonds before beginning projects. Unfortunately, all too often contractors only really learn about surety bonds after a claim has been made and they're in the the midst of a lawsuit. This article will explore some key legal points that local contractors should know about Tennessee surety bonds.
What exactly are surety bonds?
Surety bonds are not insurance policies. Although insurance companies almost always underwrite surety bonds, they do not function in the same way. Insurance agents expect claims to be made against insurance policies. Conversely, surety providers do not expect claims to be made against bonds, and, if they are, the surety expects the contractor to pay for costs.
Surety bonds are risk mitigation tools that are used to reduce instances of fraud and malpractice across a number of different industries. In the construction industry, surety bonds are also called "contract bonds" or "construction bonds." Government agencies require the use of specific construction bonds that vary depending on the project type and its geographic location. Common ones include bid bonds, performance bonds and payment bonds, just to name a few. No matter the specific bond title, though, they all work in the same basic way.
How do surety bonds work?
Each surety bond that's issued essentially functions as a legally binding contract that joins three entities together.
- The principal is the contractor or construction firm that purchases the bond to guarantee the quality of future work.
- The obligee is the government agency or other project owner that requires the bond to protect against financial loss.
- The surety is the agency that executes the bond and acts as an intermediary between the principal and obligee.
If a principal fails to meet the bond's terms, then the obligee can make a claim on the bond to gain reparation. If the claim is found to be valid, the surety will be held responsible for paying the claim. The surety then expects the principal to repay the agency for all costs, which is a major distinction between surety bonds and insurance policies.
Who benefits from surety bond protection?
Generally speaking, contractor bonding provides legal protection to government agencies and other project owners who fund a construction project. Most contract bonds are required in case a contractor leaves a project incomplete or does unsatisfactory work, in which case the obligee can make a claim on the bond. Who exactly receives the bond's financial protection, though, depends on the bond's language. For instance, payment bonds actually protect subcontractors and material suppliers by guaranteeing they will be paid for their services.
Which laws require contract bonds in Tennessee?
A number of different laws regulate the use of surety bonds in Tennessee. For starters, the federal Miller Act requires the use of separate payment and performance bonds on every publicly funded project that's contracted for $100,000 or more. The Tennessee Board for Licensing Contractors does not require construction professionals to post a surety bond to get a contractor's license, however, surety bonds can be required for bidding or obtaining contractor permits from local government agencies in the state. Exact contract bond requirements vary by jurisdiction, so contractors should check with the government agency that enforces local construction regulations before beginning any project.
Surety bonds and the Tennessee home improvement contractor license
To get a home improvement contractor license in Tennessee, applicants must provide original proof of $10,000 worth of financial responsibility via either a 1) surety bond with written power of attorney attached, 2) cash bond, 3) property bond or 4) irrevocable letter of credit.
How do contractors get a Tennessee surety bond?
The first step to getting a surety bond is to find a surety provider that best meets the company's needs. The surety industry's leading providers offer online services to help Tennessee contractors get the surety bonds they need as quickly and easily as possible. Contractors can fill out online applications in just a few minutes.
Surety providers will conduct a thorough background check to decide whether an applicant qualifies for a contract bond. This typically involves an examination of the applicant's financial history, credit score and work record. If a business shows signs of financial instability or poor performance, the surety provider will simply refuse to issue the bond. If a contractor fails to secure the necessary bond(s), the business will not be able to legally work on the project. Ignoring surety regulations can result in heavy fines, legal action and license revocations.
Once a business secures the bond, it makes a legally binding promise to fulfill the bond's contractual language. This typically means the contractor agrees to finish the project at hand according to contract.
Although it might seem complicated, the goal of the surety bond process is twofold:
- keep financially unstable or otherwise unqualified construction professionals from working in the market
- protect government agencies, project owners and consumers from financial loss
Since surety bonds play such an important role in Tennessee's construction industry, a basic understanding of their functionality can help contractors undergo the process much more easily.
Danielle Rodabaugh is the editor of the Surety Bonds Insider, a publication that provides in-depth analyses of developments within the surety industry. The publication is sponsored by SuretyBonds.com, a nationwide surety bond producer that helps contractors and their lawyers understand the legal implications of the surety bond process.