If you are in the business of construction, you have probably heard of performance bonds. It can easily be mistaken for bid bonds as both of them are usually needed in public and private projects. However, it’s best that you understand what a performance bond is so that you can understand why it costs as such.
What is a performance bond?
A performance bond is another kind of surety bond that guarantees the project owner that his project will be made and fulfilled based on the terms and conditions of his contract with the contractor. A performance bond is issued by a guarantor wherein he is jointly and severally liable to the project owner if ever the contractor defaults.
How does a performance bond work?
A performance bond works when a formal claim is given by the project owner because the contractor is in default or if the contractor themselves have claimed a default. However, you do not have to wait for them to say so for you to enforce the performance bond.
As a project owner, one of the things you can do when you notice signs of default is to contact the guarantor. The guarantor can help you contact the contractor or look for ways by which the damages will be fixed. Most of the time, the guarantor is the one who looks for a contractor that will replace the defaulted contractor. If not, they will be the ones to shoulder the cost of the project as they are also liable to the project owner.
How much is a performance bond?
There is no one figure for the cost of a performance bond. The cost varies per project and the credit score of the contractor. However, most of the time, the cost of a performance bond is 1% of the whole value of the contract. So, if the contract is worth $400 thousand, the performance bond is more or less $40 thousand. There are also cases where the project costs more than a million that the bond’s value increases by 1.5% up to 3%. If you would notice, you would not be paying the full amount of the contract. Instead, you will be paying just a fraction of its value.
Like any kind of surety bond, its cost is dependent on other factors. The contract value is one, but so is the financial capacity of the contractor. Like the bid bond, a performance bond is highly dependent on the contractor’s financial capability. This is because the guarantor wants to further be sure that the contractor has the means to fulfill the project even if he was already awarded a bid bond.
Performance Bonds and Payment Bonds
Performance bonds and payment bonds are often tied together even if they are different by nature. The former assures the project owner, while the latter assures the suppliers, the laborers, and the subcontractors (if any) that they will be paid for all the materials, labor, and other services they will provide during the course of the project.
These two are often linked together because they are done at the same time. When a guarantor issues a performance bond to the project owner, they also issue a payment bond to the contractor’s constituents. Not only are they often issued together, but they also serve the same purpose – that is, to give assurance to the other parties that they will be paid in the event that the contractor defaults.
Other Things You Need To Know
Aside from knowing how much a performance bond costs, you should also understand what it cannot do for you as a project owner.
A performance bond is not easy cash because it will only be given to you when the contractor defaults or when certain terms and conditions are not fulfilled by the contractor. At the same time, a performance bond does not take away other problems that may arise when a contractor defaults. Yes, the guarantor is responsible for looking for another contractor, but they should not be held accountable for other construction matters.
To know more about what a performance bond does and how it can be processed, you can consult Investopedia for information regarding performance bonds.