Contractor License Bond Claims Guide

Contractors will say it is not a matter of ‘if’ a complaint will be filed against them, but ‘when’. The same would be said concerning a lawsuit. 

The contractor license bond is just one of many parts in an often muddy situation of contractor disputes. As the surety bond provider, Jet Insurance Company provides two very important functions: (1) defense for the contractor against unwarranted or fictitious claims and (2) a means of recompense for those financially damaged by the contractor.

Not all contractors are required to have a license bond, but many do whether it is required by the state, county, or city. The bond serves the function of a financial guarantee from a third-party financial institution to those damaged by contractors. Like it or not, there is historical evidence of contractors causing damages and not making restitution. Regulators mandate this surety bond as a tool to build confidence in the construction industry and to win favor for solutions they have put into place but do not have to manage.

At Jet Insurance Company we want contractors whom we serve and defend to have the knowledge of the following:

1. Who can file a claim? 
2. Why are claims filed?
3. When a claim can be made?
4. How much the claim can be for?
5. What is the claims process?
6. How to mitigate financial loss and stress of the process

It must be stated that each jurisdiction has different contractor laws. Contractors should know the rules surrounding their trade in their community before entering a contract. This article is not definite for each jurisdiction specifically but provides a guideline that is generally followed by all.

Who Can File a Bond Claim? Why Would a Claim Be Filed?

It starts with a complaint that can eventually turn into a bond claim, but who can complain, and for what reason? While specific laws vary from state to state, let’s break down the specifics that contractors should be aware of.

Customers

Construction work is great, except for those doggone customers. This is where most complaints are coming from and they can happen in more ways than one can count. If any person is damaged by departure of contract specifications or violation of law, then a complaint is justified. Here are a few examples:

• Unfinished work
• Job abandonment
• Faulty workmanship
• Subpar workmanship (not to industry or regulatory standards)
• Damage to property
• Omission or deliberate departure of contract specifications
• Performing unnecessary work
• Overcharging for necessary work
• Front-loaded contracts
• Charging too much down
• Excessive progress payments
• Failure to remove mechanics lien
• Failure to pay a subcontractor or supplier that leads to their lien on the project owner

Employees

Did you pay your employees for the job performed? If not, they can pursue the contractor bond to receive restitution. 

Suppliers

Did you pay your vendors for supplies and/or equipment? This might not be permissible as a bond claim in some jurisdictions but can lead to other significant actions against a contractor or the project owner.

Subcontractors

Much like a supplier who doesn’t get paid, a subcontractor can file a mechanics lien. Should the project owner have made all payments to the general contractor, they are certainly going to seek remedy.

Regulators

Not all government agencies can or want to go after contractors, but in some jurisdictions, the regulator can go directly after a contractor in lieu of the consumer complaint. There are stipulations that penalty fees administered by regulators are not eligible for a surety bond claim.

When Can a Bond Claim Be Made?

Bond’s Active Period

A claim can only be made against a surety bond for actions occurring when the bond was active. This is from the bond’s effective date to its expiration date. 

However, each bond form contains a cancellation period. You can think of this as a grace period where the bond is still active even after cancellation. Regulators enjoy this provision as it gives a window of coverage to the public when a contractor's operations may be in flux and potentially greater risk exists. 

The cancellation period is typically an additional 30-90 days following the date the regulator receives a bond cancellation notice from the surety company. A bond claim can be made for any damage caused during that cancellation time period.

Statute of Limitations

A complaint does not have to be made immediately. The damaged party has the opportunity to make a claim against a past occurrence, however, the time period to do so is not infinite. There is a limitation to the liability faced by the contractor and subsequently the surety company. 

The bond’s liability tail varies within each jurisdiction as well as who is filing the claim. Below are a few examples.

How Much Is Covered by the Bond?

Each jurisdiction will vary in what amount of coverage, or bond limit, is deemed necessary to cover the risk a contractor poses to the public. For example, California  has a $25,000 bond limit. You might say, “that is not enough to cover most projects and risks” and you may be right. Why would California have a limit so low? Could it be to keep costs down for contractors’ bonding to ease the blow of increasing their fees? 

Regardless, that bond limit is the maximum amount that the surety company will pay out. Lawyer fees and court costs can be added to the claim amount in certain states, never to exceed the bond limit.

Multiple parties can make a claim against a single contractor license bond. Should the total claim amount of all claims be under the bond limit, all parties receive full compensation. If the total amount exceeds the limit, the parties are paid on a pro-rata basis. Meaning the claimants receive a percentage based on their total claim amount versus the other claimants.

Claims may come in at different times and until a check has been sent out, Jet will review the submission and pay on a pro-rata basis as necessary. Surety companies can ask for time extensions to make payments should extenuating circumstances arise, such as more claims coming in.

Contractor License Bond Claim Process

From the outset of a complaint, there are three separate entities that can be brought into the dispute: the regulator, the court, and/or the surety company—all three want the same outcome. The best result is for the complainant and the contractor to reach a resolution on their own without a third party's involvement. 

The irony is not lost that courts, licensing boards, and surety companies only exist due to the fact that people cannot always settle grievances independently, yet each institution truly wants people to be able to reach a compromise without their assistance.

In an attempt to avoid repeating this one fact throughout this analysis it must be stated now—at any time a contractor or the complainant can reach an agreement and solve a dispute. This ends further disciplinary action, stress, and financial burden. 

Complaint

An issue can arise for a variety of reasons and the complainant should go straight to the contractor. They may go straight to the local court or the regulator overseeing contractors, but even then officials will usually ask the complainant if the contractor has been contacted. Some jurisdictions will demand the contractor be allowed to address the complaint within a reasonable period before a formal complaint can be filed. 

A claim sent directly to a surety company before any formal complaint is filed is generally sent back to regulators or the court, per the laws governing the surety company and contractors in that jurisdiction. In some jurisdictions, like the State of Oregon, a bond claim cannot occur until after a court awards damages.

Investigation

Certain regulatory agencies will send their own investigator to the job site, often requiring that the project owner and the contractor are present. A mediator may also be utilized by some agencies.

 The hope is that the investigator can get the two parties to find a resolution without there being any regulatory actions. The investigator is on a fact-finding mission. Evidence needs to be gathered to determine if an infraction has occurred against the contract or law and, if so, to what extent. 

Cool fact: per the Oregon Construction Contractors Board “80% of the disputes are resolved at mediation when both parties participate”. 

A surety company's investigation is typically a review of the investigator or mediator's findings. The surety company can do their own discovery to aid in their decision on whether the claim is valid or not. 

Let’s not pretend that bias and incentivization do not exist. State-hired investigators are biased toward the public and surety companies are incentivized to the contractor as sureties do not make payments to the public and defend their client (unless it’s legitimate). A neutral mediator is least likely to be biased but will cost the hiring party upfront cash.

Corrective Action

Some jurisdictions, like Nevada and Arizona, give the investigator the authority to issue a corrective order if the contractor has caused damages. Other times this first-order may come from a regulatory board’s review.

The contractor is to fix the problem or to pay for damages caused, if valid. Unfortunately, contractors may not adhere to this order for a variety of reasons: pride that they are in the right, too busy to respond in a timely manner, or disappearing entirely. The best and only reason not to comply is that the contractor is truly not guilty of any infraction. However, this must be proven—escalating this judgment to another higher authority will cost time and money or may not even be an allowed option.

When complainants look for financial help during these proceedings, some jurisdictions send them directly to the surety company holding the bond. With the California Contractor State License Board, public information is available on each contractor along with their surety company (and prior surety companies). The California Board is more than happy to tell a complainant to just call the surety company and they can deal with it. However, your average surety carrier will still default to the determination from the regulator agency.

Formal Hearing or Court Proceeding

For jurisdictions that don’t hand down the authoritative power to a ‘Judge Dredd’ type investigator, a hearing or secondary decision process may be conducted by the regulator or board overseeing contractors.  

Contractors are given a chance to formally make their argument as to why the complaint should be dismissed. A hearing provides a more democratic approach before making any determination.

As mentioned before a complaint can go directly to the courts and leave the decision to a judge. Evidence must be gathered and presented to make the best of one’s case to the court. Once again a mediator can be employed by a contractor to aid in a contractor’s argument.

Some jurisdictions, like the State of Washington, require the courts to handle all suits against contractors and will only aid in serving papers or recommending mediators. 

Final Order

A final order may have already been handed down after the initial investigations before a formal board or court hearings. Nonetheless, when faced with a demand to make recompense a contractor is obligated to comply.

There may be additional penalties and fees piled onto the original claimant's complaint. A definitive timeline will be given to comply. Whether or not compliance happens is a different matter and when people are unwilling to amends for their wrongdoings is why surety bonds exist.

The surety bond can have a claim at any point, however, it is after the final order is not complied with that the bond claim typically will come in. The process of the complaint and the decisions handed down by inspectors, regulators, or judges make a bond payout a near forgone conclusion. Yet, Jet Insurance Company still believes in its duty to investigate any malfeasance or unwarranted claims.

Recovery and Indemnification

The surety company has just fulfilled its financial obligations originally set in place to protect the public from contractors and made payment to the claimant. The payout by the surety company does not release the contractor from the original obligation. 

Surety bonds are very different in the way that the surety company must be indemnified (paid back) by the contractor after a claim payment. Unlike insurance, surety bonds are not covering accidental damages, but deliberate actions, contract diversions, or poor workmanship.

States will typically place a contractor’s license under suspension until the surety company has been reimbursed by the contractor. The original complaint may have fees and court costs added to it which also need to be reimbursed. A contractor’s failure to restore the bond to its full amount by paying back the surety company may result in revocation of the license, therefore leading to the inability to be a contractor in the state, county, or city, the license was originally issued in addition to other jurisdictions.

Some jurisdictions, like the States of Arizona and Nevada, also have recovery funds that contractors must pay into to protect the public from financial loss. These are generally geared for residential customers. The surety bond is typically tapped first and then the government will make payment from its coffers.

Mitigating Losses

Ironclad Contracts

Do what you say and say what you do—easy enough right? Except a contractor's job is riddled with surprises, risks, and potential pitfalls. The contract entered into needs to account for these potential problems. 

Understanding what is allowed in the contract within your jurisdiction is key. Hiring a consultant (lawyer) upfront to construct the framework of your contract might save you from hiring a lawyer to defend you from what could have been a preventable situation.

Make sure the project owner is aware beforehand of what they are signing for and of any potential project issues. Should a complaint arise the signed contract is a great tool to utilize to squash any ridiculous complaint.

Take Complaints Seriously

Project owners are not always right because unlike a customer (who is always right) there is a big difference between selling a cheeseburger and remodeling a kitchen. However, contractors need to treat complaints seriously despite how absurd a complaint might be. The contractor is the expert in the situation and the project owner may just need some education on what is possible.

Keeping the communication lines open and being responsive to the project owner is a great practice. Appeasing a small complaint quickly and without confrontation can squash what could turn into a larger and more costly beef. 

Admitting fault for delays and mistakes that are valid and setting a timeline to address them can go a long way. It is unlikely an unfinished project or defect will just be swept under the rug by the project owner as they are most likely staring at it every day.

Some people are quite crazy and will launch an unwarranted attack. A good contract helps, as mentioned before, but so does a level head and a focus on finding a solution favorable for both parties. Get the customer to write down what you can do to resolve the issue, have it notarized, and then get it done.

Know What Different Insurances Do

Surety bonds can cover many issues for the benefit of a financially damaged party. The surety bond best fits as protection for project owners when a contractor fails to uphold their warranty—meaning the work is subpar, does not work properly, or is not complete. 

There are other coverages better suited for other risks and with better results for the contractor. Let’s look at the other coverages and how they alleviate risk for a contractor.

General Liability covers accidental damages to other property or people. It does not include coverage for the work being performed. For example, a general liability policy will provide a claim payment when a plumber burns down a house due to torched pipes causing a fire. The house is covered by the liability policy, the pipes are not. This is often required by many jurisdictions or project owners.

Professional Liability will pay for legal costs when a contractor faces a lawsuit for negligence, oversight, or simply not performing according to the contract. While not as commonly purchased as General Liability (as it is not typically mandatory) Professional Liability can be added to a General Liability policy. This coverage pays only for legal costs, not to be confused with covering the damages themselves.

Workers' Compensation covers injuries sustained by a contractor’s employees. A surety bond will never cover these damages. Contractors who work for themselves are not covered by a workers comp policy, they are covered by their own health coverage.

Builders Risk covers damages to unfinished structures that arise from weather, fire, theft, and vandalism (much like a homeowner’s policy). Once the job is complete the homeowner’s policy takes over these perils.

Inland Marine or Tool Coverage is for a contractor’s stolen equipment and Commercial Auto Insurance covers damages arising from and possibly to a contractor's vehicle fleet. A surety bond cannot assist in either case.

Mitigation Services

We return to this topic one last time. Regulators believe in third-party mitigators, sometimes through their own departments. But, the evidence is present that mitigation services yield fruit when it comes to disputes over a contractor's service. 

Can a contractor benefit from hiring another contractor to provide their opinion, whether beneficial or not to a dispute? It all comes down to the cost of addressing the complaint to the project owner's demand, the cost of the mitigation service, and the cost of the potential risk of letting the regulator or court get involved.

Part of the Better Business Bureau? The BBB offers dispute handling and resolution for contractors who are members of their organization.

Read More About Contractor License Bond Requirements