8.3 Surety Bonds in Construction

The Three Parties

A surety bond is a three-party guarantee, and the exam tests the roles directly:

• Principal — the contractor whose obligation is guaranteed. The principal buys the bond and, critically, indemnifies the surety: if the surety pays a claim, it can recover from the principal. A bond is credit, not insurance.
• Obligee — the party protected by the bond: the project owner on private work, or the government on public work.
• Surety — the bonding company that guarantees the principal's performance or payment to the obligee.

Because the surety expects to be repaid by the principal, bonding capacity depends on the contractor's financial strength, track record, and backlog — which is why "Can you get bonded?" is itself a qualification question on public bids.

The Three Core Bond Types

Bid Bond

A bid bond guarantees that if the bidder is awarded the contract, it will enter the contract and furnish the required performance and payment bonds. If the low bidder walks away, the surety pays the obligee the difference between that bid and the next-lowest bid (up to the bond penalty). Bid bonds protect owners from frivolous or mistaken low bids. On Maryland state work, bid security is commonly 5% of the bid amount.

Performance Bond

A performance bond guarantees completion of the contract according to its terms. If the principal defaults, the surety must finance the contractor to finish, tender a replacement contractor, or pay the obligee the cost of completion up to the bond amount. Performance bonds on public work are typically written for 100% of the contract price.

Payment Bond

A payment bond (labor and material payment bond) guarantees that subcontractors and suppliers are paid. It matters most on public projects, because mechanic's liens cannot attach to public property — the payment bond is the unpaid sub's or supplier's only real security. On federal and Maryland public work, claimants who were not paid follow the bond claim procedure instead of the Title 9 lien process.

The Miller Act (Federal Work)

The Miller Act (40 U.S.C. §§ 3131–3134) requires the general contractor on federal construction contracts — generally those exceeding $100,000 — to furnish both a performance bond and a payment bond. Subcontractors and suppliers who are unpaid on federal jobs cannot lien the federal building; their remedy is a claim against the payment bond. A claimant with a direct contract with the prime has strong rights; second-tier claimants (e.g., a supplier to a subcontractor) must give the prime written notice within 90 days of last furnishing to preserve bond rights. Suit on a Miller Act payment bond must wait at least 90 days after last furnishing and be brought within one year.

Maryland's Little Miller Act

Maryland's analog — the Little Miller Act, State Finance and Procurement Article, Title 17 — requires bonds on state public works contracts exceeding $100,000: bid security (commonly 5% of the bid) plus performance and payment bonds, each typically 100% of the contract amount. Local governments (counties, school boards, municipalities) have parallel requirements. The same logic applies as federally: no mechanic's liens on public property, so the payment bond is the remedy. Unpaid claimants who contracted with a subcontractor rather than the prime typically must notify the prime (commonly within 90 days of last furnishing), and suit on the bond generally must be filed no earlier than 90 days after last furnishing and within one year after final acceptance of the public project.

Bonds in MHIC Law — Two Tested Rules

1. The Homeowner's Right to Request a Performance Bond (Bus. Reg. § 8-501)

Maryland's Home Improvement Law gives homeowners a unique protection: every home improvement contract must disclose that the homeowner may request that the contractor purchase a performance bond for additional protection against losses not covered by the MHIC Guaranty Fund. The tested nuances:

• It is the homeowner's right to request — the contractor is not obligated to pay for the bond. In practice the homeowner bears the premium cost if they want the bond.
• The bond is supplemental to the Guaranty Fund, not a replacement: the Guaranty Fund already compensates owners for actual losses caused by licensed contractors, subject to its caps, while a performance bond can cover completion losses beyond the Fund's reach.

2. The License Applicant's Bond Alternative

An MHIC license applicant must demonstrate financial solvency as part of the application. MHIC does not publish a fixed minimum net-worth figure — no specific dollar number is stated on the Commission's official materials. What is published is the bond alternative: an applicant who cannot make the required solvency showing may instead satisfy the financial responsibility requirement by posting a surety bond, and the official MHIC bond form is written for $30,000. That $30,000 is the bond amount on the form, not a stated net-worth minimum — a distinction the exam can exploit. This is a license bond protecting the public, distinct from the project-specific performance bond a homeowner may request — do not conflate the two on the exam.

Common Traps

• Treating a bond as insurance — the principal must reimburse the surety; insurance spreads risk, suretyship extends credit.
• Swapping the roles: the principal is the contractor, the obligee is the owner — exam questions flip these deliberately.
• Saying an unpaid sub on a public job can file a mechanic's lien — the remedy is the payment bond.
• Saying the MHIC § 8-501 rule requires contractors to buy performance bonds — it only gives homeowners the right to request one, at the homeowner's expense.
• Confusing the Miller Act (federal) with the Little Miller Act (Maryland state work) — both center on the $100,000 threshold, but they govern different projects.