603 Types of Bonds

• Jurisdiction: Arizona

(a) General

Surety bonds provided by contractors in connection with construction contracts come in various types and forms.

Construction bonds come in many types and forms. It is important to know the differences, whether representing an owner who will require a bond or a claimant who is presenting a claim to the surety. There are four basic types of bonds now used in the construction industry: (1) bid bonds, which guarantee that the contractor will enter into the contract; (2) performance bonds, which guarantee performance of the contract; (3) labor and material payment bonds, which guarantee payment of labor and material used in the construction; and (4) combination bonds.

In representing owners or contractors who are obtaining such bonds, one should require both a performance bond and a labor and material payment bond, each in the amount of the contract or subcontract. Surety companies base their premium charge on the contract price, and will provide both bonds for the same charge.

When representing a claimant on a bond, it is important to obtain a copy of the bond. The four basic types of construction bonds come in many forms. Almost all bonds have notice provisions, some requiring notice to the contractor, others requiring notice to any two of three: owner, surety, or contractor (principal). Also, the statute of limitations may vary from bond to bond. Copies may usually be obtained from the owner or architect if claiming against a contractor, or from the contractor if claiming against a subcontractor. The latter may pose a small problem at times, because the contractor also has liability for the subcontractor’s debts either under the contractor’s bond, if the owner required one, or under the mechanics’ lien act.

There are ten basic bonds that lawyers should be familiar with in the construction industry: (1) the contractor’s license bond; (2, 3) Federal Miller Act Bonds; (4, 5) Little Miller Act Bonds; (6, 7) AIA 311 Performance Bond; Labor and Material Payment Bond; (8, 9) Mechanics’ Lien Bonds; and (10) Bid Bonds.

A bid bond is a guarantee that if the bidder is awarded the contract, it will enter into the contract in accordance with its bid. A default occurs when the bidder fails or refuses to execute a contract in accordance with its bid.

Not all refusals will result in liability of the surety on the bid bond. In Marana Unified School Dist. No. 6 v. Aetna Cas. & Sur. Co., 144 Ariz. 159, 696 P.2d 711 (App. 1984), the court held that the low bidder for a public contract may refuse to enter into a contract because of a mistake in bid without forfeiting the bid bond (see Section 801(f)).

(b) Contractors’ License Bond

(1) Three Types of License Bonds

 Contractors’ license bonds come in three forms: commercial license bonds, residential license bonds, and recovery fund license bonds. Contractors holding both a commercial and residential license may post one bond to support the multiple licenses. All residential contractors must also furnish an additional surety bond or cash deposit in the amount of $75,000, or participate in the residential contractors’ recovery fund.

There has been a significant amount of tinkering with the contractors’ license statutes in general, and with the license bond statutes in particular. Since 1961, A.R.S. § 32-1152 has been the subject of sixteen amendments. For example, from 1981 through 1987, commercial contractors were not required to be licensed, and therefore were not required to furnish license bonds. More recently, the Arizona legislature created different bonding requirements for commercial and residential contractors. Other significant changes to the license bond statute include a 1981 amendment, which extends from one year to two years the time within which suit must be brought, and 1983 amendments, which permit recovery of attorneys’ fees in license bond litigation and require that certain license bond claimants must serve a written preliminary twenty-day notice. Because of these and a number of other changes, special attention should be given to the particular wording of the statute being construed by the court in any of the Arizona decisions construing contractor license and bond requirements.

Under the statutory scheme in place in January 1994, there are three types of bonds that an Arizona contractor may have to provide as a condition to receiving or maintaining a license. Both commercial and residential contractors must be licensed and provide a bond or cash deposit. A.R.S. 
 § 32-1152. The bond amount or size of cash deposit is dependent upon the estimated annual volume of business by the contractor under the particular license. A.R.S. § 32-1152(A) and (B). Commercial contractors can be required to post a bond in an amount as high as $100,000 for high-volume general contractors, and as low as $2,500 for specialty commercial contractors with an estimated annual volume of construction work of less than $150,000. A.R.S. § 32-1152(B)(1) and (2).

The bond amount or cash deposit for residential contractors varies between $1,000 to $7,500. A.R.S. § 32-1152(B)(5) and (6). Residential swimming pool contractors must provide a bond or cash deposit in the same amount, based upon volume of business, as a commercial general contractor. This is generally higher than other residential contractors doing business in equal volume. A.R.S. § 32-1152(B)(7). Contractors who apply for both residential and commercial licenses, and whose combined volume of business is less than $350,000, may elect to post a single surety bond or cash deposit to support both licenses. A.R.S. § 32-1152(B)(3) and (4).

Residential contractors must also contribute to the residential contractors’ recovery fund or furnish an additional surety bond or cash deposit in the amount of $75,000. A.R.S. § 32-1152(C). Most residential contractors elect to contribute to the residential contractors’ recovery fund rather than provide the additional bond or cash deposit, because the amount of the contribution cannot exceed $600 per year and is often much less. A.R.S. § 32-1132(B).

(2) Coverage

Commercial license bonds are for the benefit of owners and licensees damaged by the bond principal’s failure to build or improve pursuant to code or standards of the Registrar of Contractors. Residential license bonds are for the benefit of owners who are injured by the bond principal’s failure to adequately build or improve, and for those persons supplying materials, labor, or construction equipment on a rental basis in the direct performance of a construction contract. The surety’s liability is limited to the penal sum of the bond, which is exhausted in order of claims received by the surety or in order of judgments entered against surety. Recovery fund bonds are for the benefit of owners of residential property who are injured by a residential contractor who acts in violation of the laws and regulations governing contracting. The surety’s liability is limited to $15,000 per individual claimant, with a cap of $75,000.

The commercial and residential bonds required by A.R.S. § 32-1152(B) are for the benefit of owners and licensees for the failure of the bond principal to pay any sum required by the contractors’ licensing statutes, A.R.S. § 32-1101 et seq. The bonds required of commercial general and specialty contractors are also subject to claims by other licensed contractors or the lessees, owners, or co-owners of nonresidential real property who have 

a direct contract with the licensee against whose bond or deposit the claim is made and who is damaged by the failure of the licensee to build or improve a structure or appurtenance on that real property at the time the work was performed in a manner not in compliance with the requirements of any building or construction code applicable to the construction work under the laws of this state or any political subdivision, or if no such code was applicable, in accordance with the standards of construction work approved by the registrar.

Although this provision may be difficult to read and understand, at least one court is of the opinion that the above language is unambiguous. Best Paving v. Decker Constr. Co., 165 Ariz. 372, 798 P.2d 1381 (App. 1990). In Best Paving, the court held that an unpaid subcontractor was not a proper claimant under a commercial contractor’s license bond. The same would be true for unpaid material suppliers and suppliers of rental equipment.

A commercial contractor’s license bond is a limited type of performance bond, subject to claims of an owner if the licensee is a general contractor, or to the claims of a general contractor if the licensee is a subcontractor (and so on in the cases of subcontractors and second-tier subcontractors). A commercial license bond claimant must be in direct contract with the licensee, and one general contractor cannot recover against the license bond of another general contractor on the same job. Ray Elec., Inc. v. Merchants Bonding Co. (Mutual), 157 Ariz. 374, 758 P.2d 149 (App. 1988); compare Watson v. Welton, supra (holding that plaintiff was permitted to recover under a contractor’s license issued to John Watson, when plaintiff had contracted with a partnership composed of John and Donald Watson). The Watson court did not cite or discuss the decision in Bianco v. Firemen’s Fund Indem., 72 Ariz. 181, 232 P.2d 386 (1951), which held that the liability of a surety for a single principal did not extend to transactions conducted by the principal in partnership with another. In the performance bond context, the court reached the same conclusion as the Bianco decision in Mead, Samuel & Co. v. U.S. Fidelity & Guar. Co., 125 Ariz. 525, 611 P.2d 112 (App. 1980), discussed in Section 610(b).

The Watson court did recognize that the surety had no liability on its license bond issued in the name of Watson’s corporation until a contractors’ license was in fact issued to that corporation. The court followed Western Sur. Co. v. Horrall, supra, which held that a surety

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