Construction companies often undertake big, expensive projects such as sewer and road construction projects. They need an agreement to guarantee the completion of the work assigned to a bonded contractor according to the terms mentioned in the agreement. This agreement is known as a performance bond.
But, what is a performance bond? How can it help? Read on, to find out.
This agreement is a surety contract dealing with quality standards and timely project completion details. It assures the project owner that the task will be completed on time according to the set standards. It is one of the most commonly used types of surety or contract bonds in the construction and real estate sectors.
Often, this agreement is presented by the contractors to their clients for surety of the assignment undertaken and better business dealings. It assures that the contractor completes all the obligations in the contract according to the listicles of all the project requirements.
It is crucial because the contract saves the owner from financial losses and allows them to get compensation if needed later. Simply put, the agreement saves the investor money.
Who are the parties included in the performance bond?
The performance bond has mainly three parties.
- The first is the principal, who is the contractor. They will fulfill the obligations of the contract.
- The second is the obligee which is the client. The client is the owner of the construction land or the project, who will set all the obligations.
- And the last is the surety which is the financial institution. They are the guarantor who will cover the financial losses by the principal to the obligee.
The agreement is used mainly in the real estate sector by government projects to ensure that the quality standards are met. However, it is also used in private sector projects, especially large-scale ones. Since the quality, delivery time, and requirements are stricter in these projects, the agreement is a huge requirement for the clients.
Conventionally the cost of the contract is equal to 1% of the contract value. However, the guarantor’s and the obligee’s financial stability can influence the contract’s price.
Example of a Performance Bond
The state government constructs a public school. The school building project has a value of $250,000 and will cost $25 million. So, they require an independent contractor for the purpose. The guarantor is XYZ Bank which will issue the contract and cover the losses for the state government.
In this scenario, the parties to the contract are:
Principal = Independent Contractor
Obligee = State Government
Surety = XYZ Bank
The state government will lay out the commitments for the independent contractor to meet. The contractor shall finish the project according to the requirements. In the meantime, the bank and the obligee will monitor the project closely to ensure quality standards are met, and progress takes place timely.
Once the project is completed and handed over to the government, the obligee will release the payment for the project to the independent contractor. If the contractor fails to deliver the requirements, the surety will compensate the State Government for the losses and charge the contractor for their defaults and reimbursements.
Knowing the answer to, “what is a performance bond?” is relatively straightforward. It is more important to understand when it is required, and how to obtain one.
The contractors put it forward as a way of bidding and reassuring that they will deliver every requirement. So, it helps the obligee to feel safe with their investments and about the project. On the other hand, the contractor will be able to bid more efficiently and increase their chances with the client. Thus it is mutually beneficial to both parties.