If you are in the construction industry, you might have some questions about performance bonds. A performance bond is essential in the industry, and in many countries, it is mandated by the government for the contractors to provide the bond when undertaking a government project.
But before going into details about the topic, it is essential to understand what is a performance bond? It is a financial instrument that safeguards the developer’s economic interest, which is the government itself in most cases. So, in case the contractor fails to complete a project within the stipulated time or does the inferior quality of work, then the client may raise a claim against the bond.
It gives the client, customer, or the developer confidence to pursue the project and hedges their financial interest if there is any default from the contractor’s end. Performance bonds are usually paired with bid and payment bonds for further hedging.
HOW MANY PARTIES ARE INVOLVED IN A PERFORMANCE BOND?
When crafting a performance bond, three parties are involved in the process: the principal, obligee, and the surety. In this case, the principal is the contractor who needs to attain a performance bond to proceed with the project. They are the party that would be doing the work, and they provide assurances to the client regarding their performance, quality of the work, and the project’s delivery date. On the other hand, the obligee is the client or the customer attaining the contractor’s services. In most cases, these are government bodies, but nowadays, many private firms seek performance bonds before going ahead with the project. At the same time, the surety is a third party that acts as an intermediary, and commonly there is a financial institution such as a bank or an insurance company. They charge a fee to issue the performance bond. However, financial institutions do not hand out performance bonds to everyone. They run extensive background checks and check the company’s financial standing to give them the performance bond.
HOW MUCH DOES A PERFORMANCE BOND COST?
The cost of a performance bond is not fixed, but it is based on many factors. When calculating the cost of a performance bond, the primary factor is the degree of the contract that the owner wants to cover. For instance, as the contractor, an owner can cover hundred percent or fifty percent of the contract’s overall cost. Other than the cost of the contract, the financial institution looks into the financial standing of the contracting company to determine the best terms and conditions.
If the company has a strong financial position, it might get the bond at a lower rate. On the other hand, if the company’s finances are not good enough, the fees might be much higher.
HOW TO GET A PERFORMANCE BOND?
You can not go to any insurance company and ask for a performance bond; you must go through the proper channels. The company that provides performance bonds are known as surety bond companies. Firstly, you need to apply for the bond facility and qualify for it.
To be evaluated, you need to submit the contracting company’s experience and all the financial performance for the last few years. Financial reports and experience reports will help the surety to evaluate your ability.
The bond company may ask for the following information from a contractor;
- Year-end financial statements
- Net worth statements
- Contractor’s questionnaire
- Delivery date
- The company structure and hierarchy
IS A PERFORMANCE BOND DIFFERENT FROM A BID BOND?
Well, yes, these are two totally different bonds. A bid bond is made in the initial stage and submitted with the tender, wherein it mentions that the contractor is providing an average bid and will also provide a performance bond in the future. The bid bond ensures that a contractor would start working when their bid is accepted. If the contract does not execute the contract after a low bid, the project owner can raise a contract claim against the surety. Usually, the bid bond only covers up to ten percent of the cost of the total tender price. On the other hand, a performance bond, which is issued after award, can cover up to a hundred percent of the total contract cost.
So, now that you know what is a performance bond, the parties involved, the fees, and how to get one, keep a note that contractors must provide a performance bond to the government to undertake a project. Moreover, a private project owner will specify the requirements and whether they need a bid and performance bond.