In construction, a project must be completed properly, on time, and within budget. One way to make sure this happens is by using performance bonds and guarantees. These tools give financial protection to the project owner if the contractor fails to do their job.
What Is a Performance Bond?
A performance bond is a financial guarantee provided by a bank or insurance company, known as a surety, on the contractor’s behalf. An important question to consider is how is a performance bond different from a labor and materials bond—while a performance bond ensures the contractor completes the project as agreed, a labor and materials bond protects suppliers and subcontractors from non-payment. If the contractor fails to meet the agreed project terms, the project owner can claim the bond to recover costs for completing the work or addressing issues. This bond typically covers a portion of the contract value, usually about 10%.
Types of Performance Bonds
There are mainly two types:
Conditional Bonds (Based on Proof of Default):
These bonds only pay the project owner if there is clear proof that the contractor has failed. For example, if work is delayed or done badly, the project owner must show proof of the contractor’s failure to get payment.
On-Demand Bonds (No Proof Needed):
These bonds allow the project owner to ask for payment from the surety without needing to prove that the contractor failed. As long as the request follows the bond’s rules, the payment must be made.
Who Pays for the Bond?
Although the contractor arranges the bond, the cost is generally included in the contract price. So, indirectly, the project owner pays for it.
When Is a Performance Bond Needed?
Performance bonds are common in large or public construction projects. They help protect against risks like delays, poor work, or if the contractor goes out of business. They are often required before work begins.
How Does It Work?
The bond is generally prepared before the project starts. If the contractor does not meet the contract terms, the project owner can raise a claim.
For on-demand bonds, the owner can ask for payment directly.
For conditional bonds, proof of failure is needed first.
If the contractor is given a chance to fix the issue and still doesn’t, the surety can either pay money or bring in a new contractor.
Important Terms to Know
When agreeing on a bond, these are some key points:
Bond Amount: Usually about 10% of the project value.
Duration: Lasts until the project is done or during the defect fixing period.
Cancellation: Some bonds can be cancelled if both sides agree.
Expiry: Most bonds end once the project is finished and inspected.
Claims: The process for raising and resolving claims must be clear and fair.
How to Enforce a Performance Bond
To use the bond:
Find the Problem: Clearly show how the contractor broke the contract.
Review the Bond: Make sure the issue fits the bond’s terms.
Notify the Surety: Provide proof and details.
Investigation: The surety checks everything.
Compensation: If the claim is valid, the surety pays or arranges a new contractor.
Conclusion
Performance bonds and guarantees are important tools that help ensure construction projects are completed properly. They protect project owners from delays, poor work, and financial loss. Understanding how they work helps everyone involved stay safe and prepared.
