Knowing how performance bonds work is vital if you’re a construction company or contractor. They’re an essential part of the surety bond process and are required by many government projects and private developers. They protect both parties in a construction project by ensuring they fulfill their obligations. It includes completing the project within the agreed-upon timeline and to the owner’s satisfaction.
What Is a Performance Bond?
Performance bonds guarantee a contractor will perform a project according to the terms of an initial contract. It can help protect both the contractor and the project owner from financial loss if a contractor fails to complete the agreed-upon work. A surety company or bank issues a performance bond to ensure a contractor finishes the job on time and meets the specific standards in the initial contract.
The project owner may file a claim against the bond to recover damages if a contractor fails to comply. A performance bond construction typically involves a principal (the person or company performing the work) and an obligee (the party receiving the work). The principal is usually the primary entity performing the work, while the obligee may be an individual, company, government or other type of organization.
How Does a Performance Bond Work?
A performance bond ensures that a contractor will carry out the project by the conditions of the agreement. If the contractor fails to meet these obligations, the owner can claim against the bond to receive compensation for losses. A project owner may also require a payment bond to ensure that laborers and suppliers are paid for their services on the job.
A surety typically issues these bonds to reduce the risk of a job not being completed and protect the owner from additional costs. The cost of a performance bond is about 1% of the value of the contract but can vary depending on the creditworthiness of the contractor. The duration of the contract, warranty timelines and more can also impact the cost.
What Is a Payment Bond?
A payment bond, also known as a labor and material bond, guarantees that the contractor will pay subcontractors, suppliers and material vendors for the work they perform on a construction project. The bond typically covers all labor, rental equipment and specially fabricated materials directly incorporated into the project. It also covers the general contractor’s failure to make timely payments under the construction contract.
This bond is often purchased before the project begins to protect subcontractors and suppliers from financial loss if the contractor fails to pay them. On the other hand, a performance bond is designed to guarantee that the contractor will complete the project as per the construction contract. It is a contract surety bond statutory on federal projects (Miller Acts) and is required for public construction projects in most states (Little Miller Acts).
What Is a Surety Bond?
A surety bond guarantees that the principal (the business owner) will uphold their responsibilities if a contract requires it. It is usually a project contract but could also be a business license or other type of obligation.
A contractor must secure a surety bond before working on a particular job. It is a way to ensure they will complete a job in compliance with specifications and pay subcontractors and suppliers on time. A performance bond is among the most common bonds in the construction industry. Project owners often require these in both the private and government sectors.