If you find that your construction company is expected to provide a performance bond as part of a project, that’s a good thing. It means that you have won a bid and are preparing to start a job.
When your company starts bidding on projects for cities, states, municipalities, or even general contractors, you’ll be expected to provide assurance that your company can meet the obligations detailed in the contract. Not only does the performance bond guarantee your ‘performance’ on the job, but also that your company can pay for losses if you deviate from the contract.
This assurance comes in the form of surety bonds. Basically, a surety company steps in and guarantees the contractor’s performance.
(Fun Fact: any federal government construction project that exceeds $100,000 is required to have a performance bond. Such requirements differ between state and local municipalities. We’ve known local cities that require contract bonds on projects as low as $20,000).
Allow us to get a little technical for a moment (we apologize, but it helps to know the terminology). In this arrangement, the contractor is known as the “principal”, the “obligee” is the client (the one who receives the obligation), and the “surety” is the organization that ensures the principal’s obligation.
Surety companies have the assets necessary to pay the obligee if the principal can’t fulfill the obligations of the contract. You may have heard of some of the top surety companies, such as Developers Surety and Indemnity Company, Old Republic Surety, Suretec, American Contractors Indemnity Company, etc… Don’t worry if these names are unfamiliar. You won’t be dealing with these guys anyway. Surety companies don’t work directly with contractors. Instead, they partner with brokerages or insurance agencies, like Fusco & Orsini.
There are several different kinds of bonds that obligees typically require of the companies bidding on large-scale projects. These bonds include Bid Bonds, Performance Bonds, Payment Bonds, Maintenance Bonds, and Subdivision Bonds; all of which fall under the category of ‘contract bonding’. Some bonds are required at different stages of a contract; for example, bid bonds are due at the time of bidding, and performance/payments bonds at the time the project begins.
These bonds go hand-in-hand. If a government agency is looking for one of these bonds from their bidders, they’re probably looking for most of the others too.
Let’s look a little closer at performance bonds.
A performance bond guarantees that the contractor performs the services as described in the contract. If, for instance, the contractor wins a bid to build a new public library, the performance bond would make sure that the library does, in fact, appear on schedule and to the promised specifications.
If the contractor doesn’t complete the performance, or if the work is not up to the promised quality, the client (obligee) can make a claim against the surety company that issued the bond. The surety company will investigate, and if they find that the contractor did fail to perform, they will award damages to the obligee commiserate with the cost of the contractor’s failure.
Of course, the contractor doesn’t get off scot-free. They will then have to pay the surety company back in full.
The cost of a performance bond is based on a variety of factors, including the scope of the contract and the principal’s creditworthiness (the surety company will want to make sure the principal can pay back the bond amount if necessary).
In order to get a performance bond, contractors must usually pay a premium on the bond amount as well as interest on the bond. Again, the price will depend on the cost of the bond and the risk (creditworthiness) the principal presents.
In most cases, you will first need to obtain a bid bond before bidding on a project. Only after winning the project would you need to pick up a performance bond for the project.
Even though all this may sound complicated, surety bonds, including performance bonds, are not too difficult to get. At Fusco & Orsini, we’d be happy to answer any questions you have about surety bonds and walk you through the application process. Contact us by phone or email.