Performance Bonds: Where Can You Buy One?

performance bond - Who is responsible for the issuance of performance bonds - work table

Who is responsible for the issuance of performance bonds?

A party to a contract may be required, as a condition of the contract, to provide a performance bond. A performance bond guarantees that the obligee on a contract will receive goods or services as agreed in accordance with all terms and conditions of the issued agreement. 

The issuer of the bond itself guarantees the fulfillment of its obligation by posting monetary security with an authorized bonding agent. One common reason for requiring such a bond is to protect persons who have entered into contracts on behalf of another against financial loss due to breach or non-performance by another party. 

In most cases, States require contractors who are awarded public works contracts to provide them a performance bond from what is known as a “surety”. The contractor pays for the bond, but it is guaranteed by the surety. 

The security, which guarantees that all contract terms will be met by the contractor, is provided by an insurer or guarantor. One common example of performance bonds are those issued on public works contracts such as building roads and bridges.

What is the procedure for obtaining a performance bond?

The process of obtaining a performance bond is as follows:  The municipality takes the application and a copy of a valid special use or zoning permit to its insurer who then determines whether it will provide coverage by offering a bid for coverage from an insurance company. 

If the offer provides sufficient protection, the insurer prepares binding bid documents which contain all terms and conditions of coverage, conditions precedent to the issuance of the policy, including but not limited to the apportionment of risk between parties as well as any other relevant factors. 

The applicant can submit up to four bids from different companies along with their qualification information to the municipality who in turn submits them to its insurer for review prior to making a decision on acceptance or rejection and the insurer will then issue a bid document for all bidders that have qualified.

Who is in charge of the performance bond?

The general contractor or a construction manager as agent for the owner will be charged with securing and paying for any required performance bonds on projects unless the contract documents state otherwise.

Performance bonds are required to be approved by the owner, and they protect an owner from monetary loss if a contractor fails to meet contract requirements (e.g., completing the project on time and within budget). The bond guarantees that a supplier or subcontractor will complete work as specified in their contracts. 

Without a performance bond, there is no incentive for a contractor, subcontractor, or material supplier to do their job because they won’t be compensated if they fail. Owners can sometimes be held responsible for payment even though they didn’t receive the goods or services they paid for due to the failure of a contractor or supplier to supply them.

When is it appropriate to use a performance bond?

Performance bonds are used in construction contracts to secure the supplier’s obligations under the contract. They guarantee that the contractor will perform all of their responsibilities specified in the contract, whether they are building new facilities or developing/producing products for its client. 

However, if properly structured and drafted into the original contract, there should be no need for a performance bond at all. This article describes when it is best practice to consider using a performance bond versus an alternative contractual protection device.

A contractual obligation on the part of the contractor/supplier guarantees, by bond or some other form of indemnity, that they will carry out their construction obligations as required by contract. The term ‘performance guarantee’ may sometimes be used instead of the performance bond. 

A performance bond is not an insurance policy, namely because it does not provide compensation for loss suffered by the owner but rather protects against damage arising from non-performance under the contract. Instead, the owner should make sure that there are adequate provisions allowing for damages that would have occurred as a result of delayed completion.

What are the advantages of using a performance bond?

Performance bonds are often used with large projects, where there may be a high risk that one of the parties cannot complete their part of the project. For example, if a contractor were building a road for a local authority it may require that they provide security against their work being completed properly and within time or money loss as required by law. By providing such security against possible failure to deliver on what was contracted, then the consequences should such a failure occur would be a lot less severe.

A performance bond is a guarantee from a bank to ensure that a seller of goods or services carries out its obligation as stated in the contract. This form of security can be used anytime there is potential for non-performance by one party under the contract. 

It prevents any losses from being incurred due to late delivery, defective work, loss of materials, etc. In cases where the counterparty may have financial difficulties, this type of guarantee ensures payment through an arbitrator until both parties receive their full remuneration.

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