Contractor License Bond

The bond form is a legal document, a tri-party agreement which defines the rights and obligations of the government agency (obligee), surety company (obligor) and contractor (principal). While many bond forms use similar language, each bond form can be customized by the government agency requiring the specific bond and may contain provisions that increase potential costs for the surety company, which will ultimately be passed on to the contractor via higher bond premiums, stricter underwriting or collateral. The primary text to consider in a contractor license bond surrounds (1) aggregate limits, (2) cancellation provisions and (3) forfeiture clauses.

Aggregate Limits
Bond forms always specify the penal sum defined as the maximum amount of financial damages any single party can recover from the bond related to a single claim occurrence. Most bond forms also contain a clause which limits the amount of financial damages from all parties and all claims to a specific amount (“aggregate limit”), usually the same amount as the penal sum. For example, a $15,000 contractor bond with an aggregate limit of $15,000 will pay out no more than $15,000, regardless of the number of damaged parties or claim occurrences. Contractor bonds without an aggregate limit will be more expensive than a bond with similar coverage containing an aggregate limit.

Cancellation Provisions
Most bonds contain a provision allowing for the surety company to cancel the bond (“Cancellation Provision”) by providing a notice to the contractor and government agency requiring the bond with the cancellation taking effect within a set period of time, usually 30 days (“Cancellation Period”). Cancellation provisions allow the surety company to cancel the bond for any reason, but most often due to the contractor failing to pay premiums due, claim payouts, or material changes in the contractor’s credit score. Contractor bonds with no cancellation provision or cancellation periods greater than 30 days will be more expensive than a bond with similar coverage containing a standard cancellation provision.

Forfeiture Clause
Surety bond claims are paid by surety companies to damaged parties to reimburse that party for the financial loss incurred up to the bond penalty amount. Certain bonds contain a clause which requires the surety company to pay the full bond penalty to the damaged party, regardless of the actual damages incurred (“Forfeiture Clause”). Contractor bonds with forfeiture clauses will be more expensive than a bond with similar coverage that does not contain the clause.