What is a Performance Bond?
Performance bond definition: A performance bond is a surety bond issued to contractors, that guarantees their performance in accordance with the conditions of their contract.
Also known as a construction performance bond, this type of bond is usually required for construction projects. It is a guarantee that a contractor will fulfill all their obligations, and perform according to standards and conditions set out in the contract for the project. It also guarantees compliance with state regulations for licensed contractors.
A performance bond works as a form of protection for the project owner, or the state, that has a contract with the contractor. If the contractor fails to deliver on the contract, bond obligees can file a claim against the bond and receive compensation.
Performance bonds– like all surety bonds– are a type of agreement in which the following three sides are involved: the principal (the licensed and bonded contractor), the obligee (the private or state project owner), and the surety bond company which covers the bond.
When a claim is filed against the bond by an obligee, a claims process is set in motion. If the claim is valid, the surety must compensate the obligees for delays to the project, damages, and all other forms of financial harm they may experience, up to the full penal sum of the bond.
In case of a claim, the contractor must compensate the surety for any money the surety has paid out. Contractors should therefore always attempt to find solutions to problems on a project before they default on their obligations and a claim is made.
Questions about Performance Bonds
Who needs to get a performance bond?
Performance bonds are required in all states. Furthermore, before a contractor can work on a construction project, he or she must also be licensed and bonded with a contractor license bond in that state.
Performance surety bonds are almost always necessary for state-owned construction projects, and in particular for federal projects over $100,000. The latter is mandated by the Miller Act, which delineates the exact conditions under which contractors on federal construction projects must get bonded.
For state-owned construction projects, there are the so-called ‘Little Miller Acts,’ which also specify and regulate the conditions under which contractors must obtain performance bonds.
Finally, many private construction project owners also require their contractors to obtain some form of bond.
How are payment and performance bonds connected?
Performance bonds are protection for a project owner, whether private or public, against contractor default. A payment bond, on the other hand, is protection for a contractor’s subcontractors, including suppliers of materials as well as laborers.
While payment bonds do not directly protect the owner, they still offer a form of indirect security, since they guarantee subcontractors a form of compensation if they aren’t paid by the contractor.
A payment and performance bond are typically issued together, and by the same surety. This particularly applies federal and state construction projects, but is also true for most private projects that require bonds. Both bonds are also linked to bid bonds, because the surety which issues them has usually issued the bid bond as well.
The requirement for those three bonds to be issued by the same surety guarantees that a surety will not thoughtlessly issue the bid bond during the initial bid for a project contract. If the surety deems a contractor unfit or unsuitable to perform on a contract, it will be less willing to issue a bid bond if it knows that it will also have to issue performance and payment bonds later on.
Is it possible to only get a performance bond?
Typically, performance bonds are issued along with other contract bonds and rarely, if at all, separately. This is because performance bonds are tied in with a number of other procedures and aspects of a construction process and can rarely be issued separately.
They may sometimes be issued separately for subcontractors but this is determined on a case-by-case basis and is not the standard.
How much does a performance bond cost?
The cost of your performance bond depends on the construction contract you are awarded.
The amount of the contract is typically announced in advance, and a bid is organized during which contractors can bid and win the contract. Amounts differ and depend on the size, location and type of construction project.
The amount of your contract determines the amount of your surety bond. That, in turn, influences your surety bond cost, which is a percentage of the total amount of your bond.
This percentage is called a premium, and is determined by sureties on a case-by-case basis. The most important factor that sureties take into account when determining surety bond cost is an applicant’s personal credit score, which serves as a predictor of an applicant’s ability to repay a surety in the case of a claim.
Contractors who have a high credit score can expect a rate between 1%-4% of the total bond amount on their performance bond.
With larger contracts, such as those above $250,000, contractors are assessed even more carefully, which means that sureties take into account a number of other factors such as:
- Contractor experience and project history
- State of other active bonded projects
- Financial statements and liquidity
Based on the above, sureties will set a rate for performance bonds for such contracts. This can also increase the processing time for such bonds, due to the increased scrutiny involved in assessing the situation.
Can you get a bad credit performance bond?
Unlike with other surety bonds, there are no bad credit programs for contractors who want to obtain a performance bond. It is, however, possible for contractors who have a lower credit score to get a performance bond, under certain conditions.
Contractors who have good personal and business financial profiles have a high chance of getting bonded, even if they have difficulties with their credit score. To find out more about getting a performance bond with a lower credit score, call our surety professionals at (877)-514-5146.
How do performance bond claims work?
Performance bond claims are a complex process.
Initially, for a claim to be filed against the performance bond, an alleged contractor default must have occurred. In other words, the contractor may either default voluntarily, or the project owner may default the contract and claim a breach of contractual conditions and requirements. In the latter case, the default must be proven.
Once a default occurs, whether alleged or real, the surety company which backs the bond must begin an investigation into whether its obligations have matured. During the investigation the surety carefully assesses whether there has been a case of default at all. If a default cannot be proven, the surety may decide not to step in. Conversely, if a default can be established, the surety has to step in and assume responsibility for the situation.
In this instance, the surety can choose to provide financial assistance to the original contractor, to take over the project and tender a new contractor, or let the project owner (who is also the bond’s obligee) find a new contractor. Whatever the surety does, it will only do within the limits of the penal sum of the performance bond.
If a contractor is at risk of default and wants to avoid it, the best strategy is to notify the surety early, and begin considering ways of working on the issues that threaten the project. This strategy is among the most successful ways of avoiding performance bond claims.
It’s important to choose the right surety if you want to have stable support in times of need. Reliable sureties are those that are A-rated and T-listed - a sign of their professionalism and strong financial stability. Lance Surety Bond Associates works exclusively only with such companies. In other words, getting your performance bond through us guarantees you the service and professionalism of these sureties.
How to get a performance bond
Applying for your performance bond is rather simple. Just apply online through our application tool and submit your bond application. We will contact you soon after with a quote on your bond. For bonds with higher amounts, you may be asked to submit additional documentation which may make the process of approval slightly longer.
Bonds with smaller amounts are usually processed more quickly. Call us anytime at (877)-514-5146 if you have any questions about your bond or the application process. We’re always ready to help.