The construction industry is a resource-intensive industry where a lot of money is at stake. Hence, it becomes necessary to secure contracts for guaranteeing their successful completion. Additionally, construction companies need to ensure satisfactory work quality. This is where a performance bond steps in.
A performance bond is a surety bond which is issued to contractors or subcontractors by an insurance company (or sometimes a bank). It is a guarantee that the contractor will complete the job in a satisfactory manner.
Construction projects undertaken by general contractors as well as small business subcontractors are covered by a performance guarantee. The purpose is to provide assurance to the project owner that the contractor will actually complete the project per the contract terms.
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How Does a Performance Bond Work?
Performance bonds are an integral requirement for government projects such as roads and bridges. It comes into play in case the contractor is unable to complete the project according to the contract’s specifications. In such a scenario, the responsibility of project completion falls on the surety bonding company. They either have to pay for the completion or hire another contracting firm to wrap up the project.
In this way, a performance bond protects the project owner against possible losses in a case a contractor fails to deliver. The bond also applies in case the contractor defaults or declares bankruptcy. In this situation, too, the surety will have to compensate the owner for any losses. The amount covered under the bond defines the compensation value.
It is worth noting that only the project owner can claim payment from the performance bond. The contract has to be very specific and clear to make an effective performance bond.
How Is a Performance Bond Issued?
A contractor has to apply for a performance bond by first making a bid for a particular job. Once a project owner accepts the bid, the contractor can apply for the bond. The entire process is complex. The contractor has to undergo a stringent qualification process. For this purpose, they need to seek the services of a professional bond provider such as Swiftbonds.
The provider streamlines the process for the client. Factors such as the contractor’s reputation, customer rating and length of time in the industry influence their chances of qualifying for the bond. The surety company runs financial checks on the contractor’s business. At the same time, the contractor should also check the background of the surety.
Costing of a Performance Bond
Contractors must provide a performance bond in order to meet the contractual requirements of the projects they undertake. The premium for the performance bond becomes part and parcel of their budget. Therefore, it is important for them to understand how the costing of the bond works.
The cost may vary from project to project and company to company. Generally, the premium ranges between 0.75-3% of the project cost. It is higher for the smaller projects and lower for the bigger ones.
Having a professional bond service is a good idea. Such a service will simplify the process of procuring a performance bond. Contractors should, therefore, partner with experts to ensure smooth running of their business.
About the Author
This post was contributed by Antony, who has served as a financial advisor to reputed firms for 15 years. He often shares his views via detailed posts written for Submitcore and digital magazines.