Did you know that the construction sector is one of the riskiest and most expensive industries to be a part of? Construction companies are always at risk of being unable to complete a project, going over budget, or facing unforeseen circumstances that could lead to financial ruin. Consequently, approximately 20% of all construction projects end up in a dispute, and many of these disputes are over performance bonds.
So, the question of “what is performance bond?” is essential for anyone involved in the construction business to understand. It is also vital to comprehend the different types, what they cover, and how they work.
what is performance bond?
It is a contract that secures the completion of a project by guaranteeing the terms in an agreement set forth by the obligee (the project owner). In other words, it protects the obligee from financial loss if the contractor fails to live up to the end of the agreement.
When a project owner requires that a surety program be obtained from a contractor, the surety company evaluates the contractor’s ability to complete the project. If the surety company approves the contractor, they will provide a performance bond to the project owner. The premium for the agreement is typically a percentage of the total contract value and is paid by the contractor.
Kinds of performance bonds
Contract: These are the most common type and are required for construction projects with a value over a certain threshold (usually $100,000).
Payment bonds: It is not uncommon for construction companies to default on their payments to subcontractors and suppliers. Simply put, the agreement protects against the risk by guaranteeing that these bills will be paid in full.
Maintenance bonds: In some cases, a project owner may require a maintenance agreement from a construction company to protect against the risk of poor quality artistry or materials that need expensive repairs or replacement down the line.
What do they cover?
The terms of a surety bond will vary depending on the type and the project in question. However, they are generally designed to protect the project owner from financial losses if the construction company cannot complete the assignment specified in the agreement. Also, they will typically cover any additional costs that the project owner incurs due to the construction company’s poor performance.
How do they work?
The project owner can claim the performance bond if the construction company fails to meet their obligations. The surety company that issued the contract will then investigate the claim, and if they find it valid, they will cover the losses incurred by the project owner up to the bond’s limit. It is crucial to note that the surety company is not required to cover the entire loss and, in many cases, will only cover a portion. Also, the surety company has the right to seek reimbursement from the construction company for any money they must pay out on a claim.
In certain situations, a surety may engage with a project owner following a claim to hire a new contractor instead of giving money to the project owner.
Find the Right Company
If you are a construction business needing a performance contract, the first step is to find a reputable and experienced surety company. Some factors to consider when choosing a surety company include their financial stability, claims-paying ability, and experience in the construction industry.
So, these are some things you should know. If you are planning to get one for your construction project, work with a reputable surety company.