Performance Bonds

Performance bonds represent a contract agreement between a construction contractor and a construction project owner. According to this agreement, the contractor is obligated to provide a service for payment while the owner agrees to pay the amount in exchange for the work done.

The main purpose of a performance bond is to protect the project owner from poor workmanship and/or failure to complete the job within a specified time.

A performance bond serves as a financial guarantee for a party against the other partys' inability to meet its obligations. Generally a performance bond ensures that a contractor will complete the agreed upon specifications of a construction project including the time and quality parameters. If the contractor fails to meet the agreed standards or time deadlines, the project owner will be compensated for the costs or loss.

Performance bonds are a common practice in public construction projects. However, performance bonds can also be issued for private-sector construction projects, where they are again used to guarantee work completion performance by the contractor or compensate the project owner for low quality or unfinished jobs.

The purpose of a performance bond is to insure performance, protecting the project owner from poor workmanship performance or failure to complete the job.

Performance bonds are one of the most common types of construction bonds. Performance bonds are often issued in conjunction with payment bonds to provide a financial guarantee to project owners. Learn more about how performance bonds work, their benefits and costs, and how to obtain one below.

Performance Bonds Presentation

Information On Getting Performance Surety Bonds For Construction Projects

How A Performance Bond Works

In a performance bond the obligee or project owner is usually a city, state, local government or municipality. The federal government and in some cases a private developer are also performance bond project owners.

Often required for public works other government funded projects performance bonds ensure that hired contractors are financially and professionally capable of completing the projects they bid on.

Performance surety bond underwriter companies that bond a particular company for a project are, in essence, vetting the contractors capability of completing the specified project on behalf of the project owner.

If the contractor fails to construct the building or complete the specific construction project according contract specifications, the project owner is usually guaranteed compensation for any monetary loss up to the amount of the performance bond.

Performance Bonds History

Performance bonds have been around since 2,750 BC. The Romans developed laws of surety around 150 AD. The main principles of these performance bonds still exist today.

A construction performance bond is required on federal government construction projects exceeding $100,000 as a result of the Miller Act of 1934. Performance bonds solved a very crucial failure issue within the construction industry. Before performance bonds were required construction contractors would to intentionally underbid government contracts in order to be awarded projects. They would do so with the intent of not completing the work. Once they began work on a project they would negotiate for a price increase. Because no bond penalties were in place to prevent this, the project owner was essentially held at ransom. They had limited options to complete the project and would often have to pay the increased financial demand or fire the contractor. They would then have to rebid the project. In addition to the added time delays of replacing a construction contractor, the owner was also in the disadvantaged position of having the same problem occur again even with a new company.

How Do Performance Bonds Work

If a contractor (the principal) fails perform according to the terms outlined in the construction project contract, the project owner (obligee) has the right to recover financial damages by making a claim against the contractors bond. If a claim is valid, the surety bond is designed to compensate the project owner.

Performance bonds are fully indemnified. This means that in the event of a claim, the contractor is responsible for repaying the surety the amount of the claim plus expenses. Sometimes a performance bond allows a contractor to work with the project owner whom filed a claim to hire a new contractor in lieu of providing a cash settlement to the project owner.

Performance Bonds Definitions

Wikipedia (See Entry) defines a performance bond as:

"A performance bond, also known as a contract bond, is a surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor."

Performance Bond Components

To understand exactly how performance bonds work in construction, let us look at the parties involved in this type of bond.

Principal (Contractors) - The principal or the general contractor is the party that secures the bond for a price to work on a construction project. This price is generally a fraction of what the bond covers. The performance bond works as an incentive for the contractor to complete the project as they might have to pay back the bond if contract terms are not fulfilled.

Property Owners (Obligee) - This party requires a performance bond for contracting the construction work to the Principal. They can be government, individual, or any other type of entity. The bond ultimately protects the property owner against the risk of not getting the job finished. In case the contractor fails to complete the project on time or does not meet the expected standards, the oblige receives compensation under this agreement.

Surety Bond Companies - They are the financial institutions issuing the bond. Surety companies prequalify contractors to minimize risk to them. Whenever a contractor fails to fulfill the obligations, it is the surety that compensates the property owner until the contractor pays back the surety. This is why the surety only provides bonds to qualified contractors.

The Performance Bond Process

Performance bonds help to protect project owners from financial losses caused by a contractor's failure to complete the project or meet contract specifications.

When a construction contractor applies for a performance bond, the bank or insurance company reviews the contractors' financial history, experience, and qualifications. If the contractor meets the qualifications, the bank or insurance company will issue a bond that guarantees the contractors performance.

If the contractor fails to meet the terms of the contract, the project owner can make a claim against the bond. The bonding company will investigate the claim to validate it. The investigation process determines whether there is an actual breach. They assess the projects incomplete work. The cost of damage or loss is determined from these findings. The sole right of validating the claim lies with the surety bonding company. It is based on the terms specified in the bond. The surety can deny the claim if any of these terms are not followed.

Though the purpose of the performance bond is to protect the property owner from a contractors default, a lot of authority lies with the surety when it comes to solving the problem. They can even terminate the defaulting contractor with or without the owners consent.

Performance Bonds Cost

Performance bond costs can vary based on several factors, including the size and complexity of the project, the contractor's experience and financial history, and the type of bond required.

Typically, the cost of a performance bond is between 1% and 5% of the contract price. For example, if the contract price is $1 million, the cost of the performance bond could range from $10,000 to $50,000.

It is important to note that the cost of a performance bond is not a one-time fee. Contractors may need to renew the bond annually or pay a premium that is a percentage of the bond amount.

How to Get a Performance Bond

A contractor looking to obtain a performance bond will need to provide the bonding company with several documents, including:

>> A copy of the construction project contract or agreement

>> Financial statements for the business

>> Detailed project plans that outline timelines and project milestones

>> Listing of subcontractors and suppliers

>> Proof of insurance

The performance bond company usually performs a credit check. They also review the contractors' performance history and qualifications. They will evaluate the contractors business and decide how much of a risk is involved in issuing a performance bond for the specific construction project. If they decide to take on the risk, they will provide the correct performance bond needed for the project.

The most common way to get a performance bond is to apply for one through a surety bond company. Surety companies specialize in providing this type of bond. They will help the contractor determine if the proper type of performance bond needed for the specific. Performance bond broker companies also provide contractors quotes for the performance bonds needed. The bonding company also helps contractors properly fill out and complete the application paperwork.

Finding The Right Performance Bond Broker

Choosing the right performance bond broker is an important decision that has a vital impact on a construction contractors business. When looking for a performance bond broker, it is important to find one that is reputable and has a good track record.

A performance bond broker is a professional who can help you get the performance bond that you need in order to be considered for the project. There are a few things that you should keep in mind when you are looking for a performance bond broker.

First, you will want to make sure that the broker is licensed and bonded. This will give you peace of mind knowing that the broker is a professional and that you are protected in case of any problems.

Second, you will want to find a broker who has experience in the type of construction project bond that you need.

When searching for a performance bond broker, it is important to find one that is experienced and has a good reputation. You should also make sure that the broker is licensed and bonded. Here are some questions to ask potential performance bond broker companies:

>> How long have they been in business?

>> Do they have experience with performance bonds for this type of construction project?

>> Are they licensed and bonded?

>> What is their success rate securing performance bonds?

>> Do you have references?

To start if a performance bond broker can provide fast, free quotes within 24 hours this is a good sign.

Look for a company that has the resources and industry contacts to deliver top competitive performance bond rate. If a performance bond broker has Power Of Attorney for the surety companies they work with this will help move the process of securing a performance bond along faster. Also important is if the surety bond broker can underwrite and issue bonds in house, directly from their offices. This capability indicates that the performance bond broker you are selecting to work with has a fast, efficient and effective process to secure the right bonds for your company.

Appointments with numerous established surety bond carriers enables the bonding company to find and negotiate the most suitable bonds for the specific project.

Surety bonding companies that have developed and utilized a fast, efficient, simplified performance bond quote, application, analysis, processing and approval program that streamlines the process are best at helping contractors get the best prices on the right bonds.

Personalized bond underwriting brokerage services including being available to serve clients 24-7 by phone and/or e-mail is a very important factor for contractors selecting performance bond services companies.

Putting the clients interests first, knowledge of the industry and having an extensive network of bond carriers enables the surety bond company to quickly find and locate the right bonds for your project at the best prices.

Government Projects Performance Bonds

Sometimes the performance bond requirements for these type of construction projects are different or have special requirements. This is especially true depending on the size of your company. If a construction contractor is bidding on Public Works or other government projects. It is important to find a performance bond broker that has in-depth experience in securing contract bonds for city, municipality, state and federal tax payer funded construction projects.

Performance Bonds For Veteran, Women and Minority Owned Businesses

Sometimes the performance bond requirements for construction contractors bidding on public works and other government owned projects are different or have special requirements. This is especially true depending on the size of your company.

If you own these types of businesses look for performance bond brokers with specialized processes developed to get bonds for large, medium and small veteran owned, disabled veteran, minority owned and women owned construction businesses.

Performance Bonds Information Summary

While construction project performance bonds are structured to protect project owners from work not being completed as specified and in the time specified, they also provide an excellent way to ensure the financial security of all involved parties. For project owners, they guarantee that the contract will be completed entirely and they will be compensated for the loss in case anything goes wrong. For contractors performance bonds can keep the project moving and cash flowing as they meet specific milestones outlined for partial payments in the contract.

Performance bonds are historically and continues to be very useful for pubic works, other large government projects and also for large private construction projects.

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