The construction industry is highly competitive and involves a considerable amount of risk. In the face of many physical and financial challenges, security from risks becomes crucial. A performance bond definition, is simply a legal document that promises the project owner (the obligee) that the contractor (the principal) will complete a project satisfactorily.
When getting a bond from a surety company, in some cases, it will be necessary to have collateral assets or capital to support the surety agency’s prerequisites. A performance bond is typically provided by banks or an insurance provider, which together function as a “surety.”
If you’re a builder or a company in the construction sector, you’ll most certainly need to secure a performance bond at a certain point to sign a deal with a client. With the growing need for security, you may well be required to obtain performance bonds for each development task you begin, making bonding an essential part of the construction business.
This blog explains everything a contractor should know regarding performance bonds.
What is a Performance Bond? – Definition
A performance bond, by definition, is a surety bond that an insurance provider or a bank generally issues to assure a project owner of a contractor’s ability to complete a project.
How Do Performance Bonds Work?
To safeguard the investor’s funding, the government and the private sector necessitate performance bonds and payment bonds for construction projects. If the contractor fails the venture defined in the agreement, the surety bonding company would either pay for the project’s conclusion or employ another contracting firm to finish the task for the obligee.
A performance bond is beneficial as it helps shield the investor from potential losses if a construction company fails to fulfill or is unable to execute the project as defined in the agreement.
The construction company often defaults or goes bankrupt, and in those cases, the surety is liable for reimbursing the investor for the damages. The amount encased by the performance bond is described as such reimbursement.
The payment on such a surety bond is only available to the project holder, and nobody else can claim this. The bond has to be precise about the work that needs to be done for it to be efficient, and as a result, a construction company cannot be held responsible for vague notions subject to interpretation.
A performance bond typically involves three parties, as underlined below:
- Principal – The principal person or corporate body who will carry out a binding contract.
- Obligee – The party who is subject to the duty.
- Surety – The party guarantees that the principal’s commitments will be met. Sureties are comparable to (and sometimes separate from) insurers.
To meet contract obligations, all contractors will almost certainly be required to provide performance bonds. When bidding on work, it can be challenging to provide a specific price that will encompass the performance bond unless you already have a long track record to rationalize the cost.
However, as a general principle, a contractor can expect the price of a performance bond to be around 1% of the value of the contract or even more, but this will depend entirely on the contractor’s credit standing.
Typically, and due to the construction and safety requirements scope, the performance bond and payment bond are coupled under such individual coverage.
Performance bonds guarantee that:
- The completion of a venture is guaranteed to the project’s holder.
- The owner is not required to accrue any additional costs.
The process is straightforward and hassle-free when you collaborate with a reputed surety company. The above-given information can help you get an idea of what a performance bond is and how it works.
However, it is important to also know that different projects have different applications and paperwork. So, you will need the help of a professional firm that will advise you on the best course of action for your particular project and will assist you through the application procedure to obtain the best terms for your performance bond proposal.