Over the years, investors and project owners faced significant financial challenges due to contractors’ failure to complete the project on time. This disastrous circumstance was an impetus for the development of performance bonds, which offered the owners of the projects some form of financial protection. The companies operating in the public sector were the first to begin the practice of issuing bonds. Subsequently, companies operating in the private sector started the practice.

When performance bonds were first introduced, the real estate and construction industries reaped the most significant benefits compared to other industries. The practice of issuing these bonds has become widespread across the service industry in recent years. Not only does a construction performance bond offer protection to the finance of project owners, but they also offer financial protection to investors and taxpayers.

Various kinds of service-based bonds, like CCDC bonds, Subcontractor bonds, and Form 32 performance bonds, are available. In order to provide a financial guarantee to the project owners, they are frequently issued in conjunction with payment bonds. When opting for performance bonds, here are certain factors you must consider.

Cost Of The Performance Bond

The first factor to consider is the pricing. The premium you pay for them is based on many factors, including your job size, financial strength, business years, and claim history. Generally, the premium ranges from 1-5% of the total contract price. While the cost may seem like an additional expense, it is essential to remember that the purpose is to protect your interest as owner in case something goes wrong with the project. 

In other words, it gives you peace of mind that you will not be left behind with any loss if something happens and the contractor does not complete the work as agreed.

Pay Attention To Underwriters

When contemplating the purchase of a construction performance bond, it is essential to pay attention to the person who will be “underwriting” or providing the surety. According to the provisions, the underwriter is the party responsible for paying any claims found to be legitimate. As a result, you must verify their financial background and confirm that they possess sufficient resources to pay for any claims that may arise.

Speaking with other contractors who have worked with the underwriter in the past and checking their ratings with one of these two organizations is the most effective way to gather information about an underwriter. 

• American Institute of Contractors (AIC) 
• Better Business Bureau (BBB) (AIC)

Terms And Conditions

Before getting a performance bond, ensure you understand its terms and conditions. For instance, they have a “penalties clause,” which outlines how much money will be deducted from your final payment if you fail to comply with specific provisions in the contract documents. You must understand all aspects of the agreement so there are no surprises down the road.  

• Clear explanation of the expenses, liquidated damages, and fees to be paid during the loss.
• Conditions on which the bond is revocable or invalid.
• Terms and conditions about the breach of contract by the third parties.
• A detailed explanation of the compensation amount to be paid by the surety.

Collateral Requirements

A surety company may ask for additional collateral to issue a bond in certain circumstances. If a claim is made against them, having collateral helps to overcome any potential loss. Deposits of cash, deeds to real estate, or stock certificates are all examples of acceptable forms of collateral. If the lender requires collateral, make sure that you are comfortable with pledging the assets as security. Letter of Credit, cash collateral, brokerage accounts, and real estate collaterals are some of the assets that can be accepted as collaterals for these bonds. 

Personal Guarantees

In some cases, personal guarantees may be required for a company to provide a performance bond, particularly for smaller jobs. A personal guarantee means that an individual agrees to be held personally responsible for any claims or losses arising out of non-performance under the terms of a contract. 

It means if something goes wrong and there is a claim filed against the bond, the company’s assets will be at risk, and the personal assets of anyone who has signed will be taken as compensation for the loss. Get everything in writing and understand all aspects of the agreement before signing anything.

Bottom Line

A performance bond is typically utilized in large construction projects, such as those undertaken by the government or private companies, to develop infrastructure. If the contractor fails to execute the project as agreed, the surety company responsible will step in to opt for compensation.