Construction is a famously dangerous business. As a result, many construction projects require contractors to carry a variety of bonds, each of which is meant to mitigate a specific risk. While payment and licensing bonds are increasingly frequent, performance bonds are still very common, particularly on public works projects. A performance bond protects not just the owner, but also the other parties involved in the construction project. Performance bonds work together with other construction bonds such as bid bonds and payment bonds. As a contractor, it is your responsibility to understand performance bonds and how they work before you start a new project. Below is a performance bond guide, helping contractors understand the ins and outs of this specific surety bond type.
What is a Performance Bond?
A Performance Bond is issued to guarantee the performance of an obligation under a contract or other construction agreement. The bond is usually paired with a Payment Bond and is common in the construction industry. A performance bond guarantees that the contractor will fulfill all obligations prior to the completion of the project and all tasks performed will be up to standard, codes, and regulations.
Parties Involved in the Performance Bond
All bond types have three parties: the principal, the obligee, and the surety. The obligee on a standard performance bond is the property owner or government agency, the principal is the general contractor, and the surety is the bond agency that writes the performance bond and guarantees the work of the principal.
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While performance bonds are often provided for the advantage of the owner, they can be beneficial to everyone involved in a building project. A performance bond can be crucial in ensuring constant cash flow and preventing delays or work stoppages on a project if the prime contractor fails or goes bankrupt during the project.
A performance bond claim indicates that something has gone wrong on the project, and the contractor is unable to complete their obligations. For subcontractors and suppliers, this might imply the project as a whole is in jeopardy, putting their payments at risk.
A performance bond claim requires sureties to pay the money to ensure the project is completed (though they will likely recover this money from the contractor later). It’s possible that the owner of the property will need to hire another contractor to finish the job. The purpose of a surety bond is to protect the project owner and other parties from any financial loss.
How Performance Bonds Work
Performance bonds are most commonly needed on government projects, although they may also be required for privately owned construction projects as well. A bid bond and a payment bond are usually required when a contract includes a performance bond. When bidding on a project, a bid bond is used to ensure that the contractor has the bandwidth to complete the job. A payment bond safeguards the property from title disputes and ensures that everyone involved in the project is paid, including subcontractors and suppliers.
A performance bond is generally required of the general contractor, although it can also be required of sub-tier contractors. Subcontractors may be required to post a performance bond on some government projects. To search for your specific construction bond check here.
Furthermore, under their own “Little Miller Act,” each state has adopted much of the same bond requirements for public projects. For state and local projects, the requirements will vary by region.
While performance bonds are not generally needed for private projects, they are becoming more prevalent, particularly on big commercial projects.
When a contractor obtains a performance bond from a surety agency, the bond assures the property owner that the contractor will finish the job in accordance with the contract.
How to Get a Performance Bond
Contacting a surety bond agency is the first step in obtaining a performance bond. Bonding Solutions is the nation’s leading surety agency for performance bonds. With national underwriting authority, we can help you get the performance bond you need, no matter the size.
It’s crucial to acquire a performance bond from a surety that has experience with the sort of work and project types you’re bidding on. This is because, in the case of a default, the surety will intervene and take control of the issue. They’ll need to be well-versed on all of the project’s moving elements, the labor necessary to complete it, and how to identify and evaluate suitable contractors.
Performance Bond Cost
Most Performance Bonds are required to cover 100% of the contract amount. The cost for the bond will vary based on the bond amount, but you will pay between 1 to 3% of the bond amount. Performance bond rates are often time issued on a “sliding scale”. The larger the bond, the lower the rate will get. The rate is based on the financial qualification and experience of the applicant. Performance bond approvals will be based on the capacity (ability to perform the contract), character (credit, reputation, etc.), and capital (financials, cash, working capital).
Bonding Solutions has in-house programs and underwriting authority that allow for approvals with no financials required and no minimum credit score. Apply with us today.
Claims Against a Performance Bond
The owner of the construction project might make a claim against the performance bond if the contractor fails to perform all duties specific to the original contract. If a genuine claim is made, the surety intervenes and takes corrective action.
In the case that the project owner files a claim, the surety will investigate the claim. This is done to see if there has been a breach in the contract and how much damage has been done.
The surety will analyze the work that has to be done, the cost of any adjustments, and whether or not another contractor should be hired to finish the job. A performance bond claim is usually filed in conjunction with the prime contractor’s termination. Termination, on the other hand, is not necessarily a black-and-white situation.
To avoid termination, the owner may agree to new terms. For all parties involved, terminating a contractor can be an expensive process. To keep the project going, the scope of work might be reduced, the personnel supplemented, or payments could be advanced. If that doesn’t happen, the surety will have to step in.
Every bond has particular requirements that must be adhered to in order for a claim to be legitimate, which frequently include timely notification of default. The surety has the right to refuse the claim if notification is not given in accordance with the requirements. While the performance bond is in place to safeguard the owner against contractor default, the surety has considerable control over how the problem is resolved. They may even be able to restore the defaulting contractor, with or without the owner’s agreement, in rare instances.
How to Avoid a Performance Bond Claim
Avoiding a claim from the standpoint of a contractor entails not defaulting on a contract. Even the most skilled contractor, though, may encounter an unforeseen issue. So, what should a contractor do if they suspect they won’t be able to complete the job? Pick up the phone and call. Make contact with the surety agency. After all, they’ve been trained to deal with situations like these and may be able to help.
As the saying goes, the greatest defense is a good attack, and this is true for bond claims as well. Prequalifying contractors before employing them for a contract is the easiest approach to avoid a lawsuit. Check more information at Bonding Solutions.
Surety Response to a Claim
If the contractor is found to be in default, the surety agency must determine how to proceed. Sureties have a few alternatives for resolving the claim.
- Payout. The surety will pay either the bond amount or the cost of finishing the job, whichever is less.
- Financing. A surety may determine that because the contractor was so close to finishing the job, they will fund the contractor’s completion.
- Arrangement. In this case, the surety and the client will collaborate to complete the contract’s performance. The customer will often choose a substitute contractor, and the surety will cover any additional expenditures.
- Takeover. The surety will be in charge of finding and financing a new contractor to finish the remaining work.
The contractor must reimburse the surety for any money owed to them, once the claim is made. That is why, while dealing with bond claims, communication is crucial. When issues arise, contractors should always strive to discover alternate solutions before they become too serious, and well before filing a claim.
Performance Bonds Benefit Everyone
Construction performance bonds are a great method to establish financial security for all stakeholders, even if they appear to be targeted toward the owner’s protection.
When a contractor fails to complete performance on a contractual obligation, things can spiral out of control quickly. For project owners, they are guaranteed that the contract will be completed, in full, and will be compensated in case something goes wrong. For subcontractors and suppliers, Bonding Solutions can keep the project moving forward and the cash flowing without having to deal with delays or filing payment bond claims by yourself.
As a contractor, it is important to work with a surety agency that can get you great rates and always has your best interest at heart. Working with Bonding Solutions can help grow your bond capacity. Contact our team to learn your options for obtaining a performance bond or apply directly online by clicking here!