Construction and development projects have an increasing need for finances and workforce. Specific contracts and guarantees are required for the satisfactory completion of the project. With an expected construction output of $232,243.2 million by 2026, the relevancy of the surety bonds has increased. A performance bond, also known as a contract bond, is relatively standard in the real estate development and construction industry.
Performance bond meaning refers to project completion as per construction documents. This bond is needed after successfully accepting a bid that paves the way for the contractor to start the work. If you want to know about this surety bond before undertaking your next big project, here is the information.
What is a Performance Bond?
A performance bond is typically issued by a public entity like a bank or an insurance company. They act as a surety in a three-party arrangement and ensure the project owner does not incur any monetary loss. The contractor is expected to fulfill all of their obligations under the contract with satisfactory performance.
Essentially the bond also protects the public agencies in instances like going bankrupt or the contractor cannot finish the job. The surety can either pay for the completion or bring in another contractor during this point. However, the contractor awarded the bond must refund the surety if a claim is made against the bond.
Who Is Involved in a Performance Bond?
A performance bond is created between a three-party agreement which involves:
- The principal or the contractor who is assigned to finish the project work.
- The obligee is the project owner, company, or government body.
- Sureties are the banks or any financial institutions that offer performance bonds.
How Does Performance Bond Work?
Once the bidding for a project is closed, a performance bond is issued as a promise to complete the work. Usually, private sectors and government need performance bonds to protect the project’s investment. Once the performance bond is in place, the contractor is obligated to finish the work specified by the firm or the owner. If they fail, the surety agency will pay for the additional costs or hire a new contractor.
The contractor may not offer the required materials or resources for the project work in certain situations. Under these circumstances, the surety pays off the owner for all the loss.
When Do You Need a Performance Bond?
Now that you know the performance bond’s meaning, public works and government projects such as contracting roads, bridges and buildings require the backing of performance bonds. Additionally, private projects and works may also need them. Even then, the contract terms need to be specified, and the contractor should work as per the specifications.
What Are the Benefits and Drawbacks of Performance Bond?
Performance bonds come with their fair share of benefits and drawbacks. The obligee is promised the completion of the project. Moreover, the owner is not responsible for additional costs when the contractor fails to finish. However, there are chances when the surety can claim that the owner did not stick to the bond terms. They can even persuade the owner to settle for a lesser amount, refraining from paying the total compensation.
What Documentation Is Needed?
The surety in this bond structure needs to be doubly sure if a contractor is financially stable before issuing a performance bond. For this, the financial institution may need authentic documents for verification. These include:
- Financial statements as old as two years reviewed by CPA
- Application of a surety agency
- A copy of the contract related to the performance bond
- Collateral deposit or other properties in your name
Conclusion
Though performance bonds are not insurance, they protect the parties involved in large-scale construction projects. These bonds assure high-quality work from the contractors and safeguard the owners from any unfortunate events.
