Performance Bond

Performance bonds provide a kind of guarantee that a construction project will be satisfactorily completed and that a contractor will live up to all the terms specified in the bond, to the satisfaction of the project owner. Having a contract performance bond in place is important and is often a required step to securing a contract.

Both the government and private sector companies require performance bonds as protection against noncompliance or failure to complete a project by the contractor. In the case of federal construction projects, these projects often involve the building of bridges, roads, and other structures that will be made available to the public.

When the contracting company fails to live up to its obligations on the project, and for whatever reason can't complete the specified body of work, the bonding company may be obliged to pay for the completion of the project, or secure the services of an alternative contracting company for the completion of the detailed project.

Bonds include terms that the contractor must live up to, and which constitute the project owner's evaluation of what constitutes a complete project. If the contractor fails to meet any of these terms, the construction job owner would then have the option of making a claim against the bond to recover any losses that might have been incurred.

If it turns out that the contractor would be bankrupted by having to pay the amount of any claim against him/her, that would leave the surety company as the sole responsible party for making up any losses to the project owner. Because there's so much at stake in this type of bond, the terms and the language used must be very specific, because as often as not, a case like this can go to court, where the terms of the performance surety bond are subject to legal interpretation.

A payment bond and a performance bond are both types of contract surety bonds commonly used in construction projects, but they serve different purposes.

Almost every contractor who successfully bids on a construction project will have a surety bond in hand, simply because a project owner will require that kind of assurance that the job will be completed. As a general rule of thumb, a contractor can anticipate that a surety company will impose a charge of roughly 1% of the total contract value as the cost of a bond itself.

There are special cases, however, such as when the value of a contract exceeds $1 million, and in those situations, the cost of a performance surety bond might climb as high as 2%. In all cases though, the cost imposed on the purchase of a bond will be closely connected to the creditworthiness of the contractor.

Contractors who appear to be relatively unstable financially will, of course, be charged a higher amount for a bond than would a financially stable contractor with a good credit history. As another rule of thumb, the purchase of performance bonds by a contractor is generally made in conjunction with the purchase of a payment bond, so that the terms of both can be included under one comprehensive coverage.

When terms are not entirely fulfilled by a contractor, the project owner is within their right to make a claim against the bond to recover any losses that may have resulted. Initially, the surety company is responsible for paying that amount to the project's owner, assuming that the claim can be validated, either privately or through legal means.

In many cases, however, the bonding company would then have the option to pursue the contractor to recover that same amount of money, since it was the contractor's failure to comply that caused the claim to be made in the first place. It will depend on whether language is included in a bond that a bonding company has the option to pursue the defaulting contractor.

When that language is written into the performance surety bond, and the surety bonding company requires a contractor to repay the amount of a claim, a contractor is legally obliged to do so. If paying that claim would push the contractor into a state of bankruptcy, the bond issuing company would then have no recourse for being compensated for its losses and would then have to absorb any financial setback. For this reason, surety companies make a point of thoroughly screening applications from contractors who are interested in purchasing this kind of bond.