In simple terms, a performance surety bond is a legally binding contract that guarantees the fulfillment of obligations and satisfactory completion of a construction project by a contractor. The party that hires the contractor is protected by the insurance company or bank that financially guarantees the completion of the construction project in the event that something goes wrong.
We will briefly explain that there are various types of surety bonds, including performance bonds, explore in more detail the terms of a performance surety bond, and discuss how much bonds cost, as well as the roles of the main parties involved.
Types of Surety Bonds
Common types of surety bonds include performance bonds, payment bonds, bid bonds, license and permit bonds, and ancillary bonds. The requirements and regulations governing all of these different kinds of surety bonds vary by jurisdiction and the nature of the bond in question.
While surety bonds tend to protect the obligee, they also benefit the principal, as they look more credible, trusted, and reliable. So, with surety bonds, everyone is a winner. Today, we are focusing specifically on performance surety bonds.
By the end of this brief guide, you’ll be equipped with the basic knowledge to understand how a performance surety bond guarantees construction projects.
Introducing Performance Surety Bonds
A performance surety bond is a type of surety bond often used in construction projects. This bond ensures that contractual obligations are met by the contractor on a construction project. Performance surety bonds protect consumers and stakeholders from financial losses due to non-completion or misconduct by the contractor.
The performance bond provides financial assurance to government agencies or project owners that contractors will comply with regulations and licensing requirements. This facilitates trust between the main parties involved in the bond, who work in construction, finance, and insurance respectively.
How Much Does a Performance Surety Bond Cost?
The cost of a performance surety bond will vary depending on the type of bond and the client, but in general, they will cost between 1-3% of the total contract value. You can find more information on the calculation of performance surety bond costs on this site amongst others, and even apply for a performance bond in just three minutes. It’s important for contractors to work with a reputable surety bond broker or agent who can help them navigate the bond application process, assess the bond requirements, and obtain a competitive quote.
The Parties Involved (and Their Roles)
There are three main parties involved in a performance surety bond and each has a very distinct role to play in the process.
- First, we have the principal. The principal is the party who is required to obtain the performance surety bond. This could be an individual or a business that needs to meet certain legal or contractual obligations. It is normally a contractor in terms of construction projects. The performance bond serves as a financial guarantee that the principal will complete their project to a satisfactory degree, as specified in the contract.
- Then we have the obligee. The obligee is the party that requires the surety bond. This is often a government agency, project owner, or another party that wants to ensure that the principal (the contractor) performs their duties or meets specific requirements regarding the construction project. The obligee can make a claim against the bond if the principal fails to meet their obligations satisfactorily.
- Finally, there is the surety. The surety is a third-party company, such as a bank or insurance company, that provides the bond as a financial guarantee on behalf of the contractor. The surety company evaluates the financial strength and credibility of the contractor before issuing the bond. If the contractor fails to meet their obligations, the surety is responsible for compensating the project owner for any losses up to the bond’s limit. The contractor must then reimburse the surety for the amount paid out to the project owner.
A performance bond guarantees a construction project by protecting the obligee in the event that the principal does not fulfill their contractual obligations satisfactorily. If the surety has to pay out to the obligee, the principal then has to pay back the total amount paid to the obligee. The main purpose of the performance bond is to protect project owners financially in the event that the contractor does not meet their obligations, but they also function to make contractors more reliable. So, in this way, performance bonds guarantee construction projects in more ways than one. Make sure you use a reputable surety bond broker if you need one.