What are Performance Bonds?

performance bondA performance bond serves as a guarantee for project developers that a contractor will complete the work by the terms of the contract.

If the project does not meet those standards, then the project developer can file a claim against the performance bond to cover the amount needed to hire another contractor to complete the work (or there are other methods to indemnify the project developer).  In many cases, you will also obtain a payment bond along with the performance bond.

Also, there are industry standard forms established by groups, such as the American Institute of Architects, Associated General Contractors of America, and Engineers Joint Contract Documents Committee.

 

How does a Performance Bond work?

A performance bond is a protection for the project developer. If the contractor fails to meet all of the requirements of the contract, then the developer will not be out of pocket for additional costs to complete the work in the contract when they hire another company. By supplying this bond, you are giving the developer more confidence in your promise to finish the work to their satisfaction.

The contract must contain accurate information about the work to be completed. Vague descriptions of work to be done in a contract cannot be enforced if the developer attempts to make a claim against the bond.

A Performance Bond is categorized into two types.

 

What are the two types of Performance Bonds?

The first type is the conditional bond. This is where the Surety agrees to pay if and when certain terms and conditions would be any defaults, such as breach of contract, by the Contractor.

This type of Performance Bond:

  • Is a contract of guarantee where the Surety accepts joint and several responsibilities for the performance of the Contractor’s obligations under the construction contract.
  • Makes the Surety liable for the operation of the trigger clause (evidence of a financial default or breach of the terms of the contract), and the Obligee is sustaining loss as a result of such defaults.

The second type of bond is the unconditional bond. 

This type of Performance Bond:

  • Is a commitment by the Surety to indemnify the Obligee only when demand is made upon him by the latter.
  • Allows the Obligee to call on the Surety for payment whether or not there has been a default under the principal contract, granted that the call is not fraudulent.

 

Performance Bond vs. Bank Guarantee Difference

Performance Bonds, as previously mentioned, provides a guarantee of payment in case of inadequate or delayed performance of a contract.

For example:

A Contractor (Principal) and its supplier win a tender (bid) to provide Obligee with materials and equipment for $100,000. Contractor submits a performance bond. But Contractor withdraws because it cannot deliver on the agreed contract price and will incite a loss. The Obligee will file a claim against the performance bond for failure to perform the contract.

Meanwhile, a bank guarantee promises repayment of funds from a bank that a debtor’s liabilities will be met in case the debtor fail to fulfill the contract.

Bank guarantees are not the same as surety bonds.

 

Do I need to get a Performance Bond and Payment Bond together?

They often go together. Typically, surety bond providers offer both Performance Bonds and Payment Bonds in one bundle. If you are required to secure just one of the two bonds, the same rates may apply as it would for both bonds packaged together with the same application and process.

Typically, there is no additional charge when obtaining a Performance Bond with a Payment obligation.

 

Why do I still need a Performance Bond if I already have a Contractor License Bond?

A Contractor License Bond is part of getting a job for a public construction project and is required by law to ensure that any contractor working on a construction project will run its business in compliance with state rules and provisions concerning a contractor’s license.

However, a contractor license bond does not guarantee a particular contract. A Performance Bond ensures performance and completion of an obligation by a contractor and its subcontractors according to the specifications of the contract.

 

Why do I need to get a Performance Bond if they protect everyone else but me?

Construction bonds are a requirement that the Project Owner (Obligee) requires a contractor to protect itself against contractor failure and inability to make payments.

For example:

If a developer has won the construction job of an office building, the project owner would want to hire a contractor or construction company that has the experience, work history, and financial capabilities to perform the work. The Project Owner has no ability to pre-qualify the contractor, so it imposes a Performance Bond that guarantees that if the contractor does not perform the work correctly or pay its bills, the Surety will step in to make sure the contractor completes the obligation and make timely payments.

 

How much does a Performance Bond cost?

The cost of a performance bond varies depending on the amount of the project.

Typically, the cost of a performance bond is less than 1% of the contract price. But if the contract is under $1 million, the premium may be valued between 1% and 2%. The higher the amount of the contract, the greater the amount of the bond premium. Bonds may be more costly, depending on the financial strength, reputation and other factors related to the contractor.

One of our licensed bond agents will be happy to get a free quote on a performance bond for your project.

 

Where can I get a Performance Bond Form?

A Performance Bond form is mandatory.

A Surety will provide you an industry standard copy of a downloadable Performance Bond form sample. However, if the Obligee has its specific forms, you will need to get the performance bond form from them.

A bond form outlines legal terms and conditions used to make the bond guarantee, and the Project Owner decides which bond form must be employed.

 

What do I need to get a Performance Bond?

To apply for a performance bond, you will need to provide some information to qualify for bonding, along with the bond form.

Fill out and submit an application form.

A surety underwriter will examine any proof of financial capacity and work experience, so it is best to furnish all these documents. Prepared financial statements will also be helpful in determining the right rate and approving your application for a performance bond.

Documents that sureties may require you to provide may include, but not limited to:

  • Financial statements (personal, bank loan agreement copies, payables, aging receivables, revenue, cash flow, etc.)
  • Current account of work in progress
  • Certificate(s) of insurance
  • Resumés of owners/key employees
  • Letters of recommendation about the accomplishments of the company
  • Statement of qualifications for the company
  • Business information and details (may include articles of incorporation)
  • Surety relationship, if any
  • Completed contracts
  • Work references
  • Copies of any subcontract agreement

Sureties will also need to know the amount of the contract. Providing a copy of the contract may be necessary to move the process along quickly.

 

Do I need multiple applications for a Performance Bond?

You only need one application when securing a Performance Bond.

 

How long will the Performance Bond remain valid?

The duration of a Performance guarantee is based upon the terms in which it is provided. If there is no mention of a specific time limit, then the contract ‘remains in full force and effect.’ When the project is completed, contractors must enable an official closure of the bond.

 

Why do I still need to communicate with the Surety after completing a Performance Bond contract?

Contractors often believe that when they get bonded, the work begins, but they think they are now done with the Surety.

That is not the case. Once a job is bonded, the Surety may not require any additional documents from the contractor. But the Obligee does.

Sometimes, the Obligee requires that the Surety furnish a “Consent to Final Payment” or “Release of Retainage” documentation. Sureties may request documentation about the financial status and performance of the project. The contractor may not think it is necessary to communicate with the Surety at the completion of the job, but it is extremely beneficial.

Here are reasons why:

  • It involves getting the payment bond.  Claims made by subcontractors and suppliers of material and equipment are affected by the last date of their performance or supply on the project. By formally closing the contract, this creates a reference for evaluating such claims.
  • Each bond contract renders a partial use of the contractor’s total capacity.  The surety capacity is re-established by closing out the project. This facilitates future construction work.

Officially closing out a Performance Bond is also important for the Surety since this allows them to book any unmerited premiums. Also, both the Contractor and Surety are released from the risk or obligation.

 

How do I close a Performance Bond?

Whether requested by the Surety or not, the contractor must request a documented copy from the Obligee indicating that the contract has already been completed and the surety bond is released.

At the completion of the project, contractors should take responsibility in requesting closure evidence for their bond files for the continuation of work and obtaining good trade references.

Looking to post a Performance Bond? We will work quickly to get your documents for your performance bond and have them sent to you as soon as possible. Contact us today!

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