Generally, in the construction sector, bonds are made to protect the party against the monetary losses caused by the contractor. They help the party resolve their monetary losses with the help of banks or other financial institutions.
At times, the contractor fails to meet the contract requirements or find a new contractor for the task; in such cases, these bonds play a vital role.
In the construction domain, performance bonds help a lot to prevent monetary losses. Several bonding companies work in this domain to save the parties fromgetting trapped in such problems.
It is important to note that it is not insurance but a three-party agreement between the principal, the surety, and the project owner. It is commonly used in the construction industry, which provides construction services to government bodies. The other sectors in which they are required are technology, trucking, and services.
So, if your question is, “what is a performance bond in construction?”, continue to read.
Construction and real estate projects require huge monetary funds. Hence, performance bonds are common in construction and real estate projects. Contractors reassure the clients that the project will be completed on time, with all the requirements. These bonds help compensate the investor for the losses in case of some unexpected events like bankruptcy, insolvency, and many more.
In a nutshell, they provide financial protection to the project owner when the contractor doesn’t fulfill the party’s needs. Many construction projects use these bonds to protect the taxpayers and the investors. The three different parties included in the performance bond are the principal, surety, and obligee.
The principal is the main party working on the project. It can be the contractor in most cases. The obligee is the party that has given the work to the contractor. It can be the government, an individual, or a private company. And the surety is the financial institution assures the obligee that the contractor will complete the work. If necessary, they also ensure their intervention if the contractor fails to complete the project.
Cost of a Performance Bond in Construction Contract
A performance bond ensures that all project participants fulfill their obligations in construction contracts. For example, if a government project costs $10 million to complete, it will require such a bond issued by the financial institution.
In this case, if the contractor fulfills the task of completing the building, the government will have to pay the amount to the contractor after the work. But, if the goal is not achieved and the contractor fails to achieve it, the surety (financial institution) will compensate the government for the losses. Then, it will go to the contractor looking for reimbursement.
Usually, the cost of a performance bond depends on various factors like the contract value, contractor qualifications, and type of project. Typically, it ranges between 1–2% of the total contract value, depending on the contractor’s financial situation.
There is a difference between performance bonds and bank guarantees. They differ from each other on grounds like their purpose, claims, and type of contract.
Hence, to protect itself from losses in a huge construction project, one must always opt for a performance bond for proper security. They protect the project and make the whole process more seamless and professional.