Performance Bonds: What You Need To Know

February 1, 2021

A performance bond is a surety guaranteeing that the contractor will perform and complete the project as agreed. Performance bonds are mainly used by the government and contractors when undertaking large projects, and they help to ensure that all the contractors and sub-contractors get their payment. Supply bonds also help ensure that all the required material is provided. Read on to learn what you need to know about performance bonds.

How Performance Bonds Work

Performance bonds are designed to provide financial and legal protection to the contractors. The contractors secure this type of bond when working on public projects to ensure that the work is completed. If the contractor fails to fulfill their obligations, then the bonding company will satisfy the contract’s requirements. The bonding company provides surety to the parties involved to ensure that all the work will be carried out as agreed. This helps to reduce the causes of project failures. 

Here’s one example of how they work. Let’s assume that in this case, the government wants to ensure a large project will be completed. The common performance bonds used in government projects include constructing roads, bridges, and other infrastructure. A bond aims to protect the taxpayers’ investment. If the contractor fails to complete the project, the bonding company can hire another company to complete it.  

Significance of Performance Bonds

Before the work on a big project begins, the owner is mainly interested in protecting their investment. The contractor is required to provide a performance bond to make sure that the work will be completed. Insurance specialists at explain that a financial guarantee backed up by a licensed surety company helps protect the project. Should anything happen during the project, the guarantor takes over and makes sure that the project is completed.   

How to Get a Performance Bond?

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Not everyone qualifies to get a performance bond since they resemble a line of credit. Underwriting will be based on the owner’s credit for small contracts that are $300,000 or below. Underwriting guidelines from different surety bond companies significantly vary depending on aspects like the size of the contract. Underwriting for bigger deals is often more extensive. 

Cost of Performance Bonds

The cost of a performance bond usually varies depending on the size of the contract that the bond is supposed to cover. The rates of your bond facility also determine the cost of the performance bond. The standard price of a performance bond is mainly based on the percentage of the total amount of the project. The cost of a performance bond is usually less than one percent. 

The other important thing about performance bonds is that surety bond companies often provide lower rates to organizations that have strong balance sheets. This makes it possible to keep some net profit for business each year. There are also instances when premium prices for bonds might be higher. These cases usually include contracts that are below $1million. When the contractor has a poor credit record, the cost of the bond might be higher.

Regulations for Performance Bonds

Federal, state, and local laws are used to protect the regulations of performance bonds. For all projects that exceed $100,000, the Miller Act dictates that performance bonds should be used. These bonds are good for public projects since they guarantee payment for subcontractors and material suppliers. This type of guarantee helps to ensure that all work is completed on time as promised. Both the contractors and the surety bond companies should follow the guidelines provided by the licensing authorities.

The Drawbacks of Performance Bonds

There are also other drawbacks to performance bonds that you should know. In some cases, the surety may try to establish if the owner did not comply with the technical conditions of a bond so that they avoid paying compensation. The owner has to quantify the losses suffered when the contractor fails to fulfill their performance. The project owner may fail to recover payment if they underestimate the losses of the project.

Performance bonds provide surety that the contractor will get paid, and they also complete the project. The government mainly uses these bonds in undertaking large projects like building bridges and roads. Performance bonds also help to protect the taxpayers’ money. A performance bond should be utilized for any project that costs above $100,000. The cost of any performance bond is based on the total value of the project. Most performance bonds are usually less than one percent of the total value of the entire project. 

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