The Performance Bond, Explained
A performance bond is a type of surety bond that guarantees a contract will be completed according to its specified terms and conditions. Like other surety bonds, these bonds bring together three parties into a legally binding contract. Those parties include:
Those parties include:
The principal, which is the business or individual who is doing the work.
The obligee, which is the entity for whom the work is being done.
The surety, which is the insurance company that backs the bond with a line of credit in case the principal cannot fulfill the task.
In the event that the principal contractor is unable to complete the job as specified in the contract, the obligee can make a claim on the bond for the cost necessary to finish the work. The surety becomes responsible for fulfilling the contract, which usually involves hiring a new contractor to do so.
Can These Bonds Help Contractors?
While performance bonds are intended to protect project owners and not contractors, primary contractors can still benefit from them.
Contractors often need to hire subcontractors to aid in the completion of a job. Bonding is a great way to mitigate risk in the event that a subcontractor is unable to fulfill their obligations.
When a surety underwrites a subcontracting company, they’ll perform a detailed analysis of the subcontractor’s experience, insurance claims history and financial strength in order to determine whether or not they’re capable of undertaking the project for which they’re applying. This way, contractors can take comfort in the fact that they’ve hired qualified subcontractors who are fit for the job.
The Intersection of Bonds and the Law
For public construction, alteration and repair projects of Federal buildings, contract bonds may be mandatory. The Miller Act requires that any Federal public works project in excess of $100,000 be backed by both a performance bond and payment bond, which guarantees that subcontractors and suppliers will be paid the amount they are due from the primary contractor. It’s important for any contractor applying for a Federal job to understand this information.
At the state, county and city levels, laws that mandate bonds vary depending on location.