Who issues performance bonds?
In general, a contractor is required to have a performance bond when bidding on public work. A performance bond guarantees that the contractor will furnish all labor and material necessary for a project in accordance with bid documents and design plans, and compels the contractor to complete the project in a satisfactory manner under penalty of forfeiture of bid security.
A separate payment bond ensures payment to all subcontractors or suppliers who furnish labor or materials for a construction project where final payment is made directly by the owner. In this case, however, only one party is responsible for furnishing both performance and payment bonds-that is, constructing the project according to the contract. This party is called the “prime” contractor. The prime contractor may be responsible for furnishing a “joint” bond with the owner, which binds both the contractor and owner to complete the project.
Many states now require subcontractors or suppliers to furnish their own bonds-called “supplemental” payment bonds-when they are conducting work on a public project. The supplemental payment bond is designed to protect subcontractors and material suppliers in the event that (1) the prime contractor defaults on its contract, (2) construction progress is impeded by circumstances beyond anyone’s control, or (3) the financial condition of the prime contractor changes prior to final settlement. This is intended as protection for subcontractors/materials suppliers who may be delayed in receiving payment due to factors not within their control.
How do you get a performance bond?
A contractor must be prepared to submit a performance bond and payment bond with its bid. A performance bond can be an individual or blanket agreement, which requires the contractor to furnish both labor and material (and, in some cases, equipment) for a construction project under penalty of forfeiture of 100% of its bid security. The amount of the required bond varies from state to state but is usually between 10% and 15% of the contract price.
In most states, if a bidder fails to secure one or more required bonds at the time of bidding, it has not been “passed” as eligible. In other words, if a bidder does not provide all required bonds with its bid documentation at the time it submits its proposal to the owner/developer, the bidder’s proposal is rejected as being incomplete.
If a contractor is awarded a project, a performance bond must be submitted before work can begin on the site. The amount required is determined by law but usually amounts to 10% of the contract price or $2 per sq. ft., whichever is greater. At least one original performance bond and one original payment bond must be deposited with the owner before any payments will be issued to the contractor under such contracts. After all monies due on a project have been paid, all bonds may then be returned to the contractors who furnished them.
Who is responsible for the performance bond?
A contractor who is awarded a public work project in the US must provide two types of security to ensure that it will meet its obligations under the contract. The first, called the performance bond, guarantees that the contractor has the financial resources and expertise to carry out all aspects of contracted work. This type of bond is usually required when a small business applies for a large government contract.
The second type, called the payment bond, guarantees that all subcontractors or suppliers who furnish labor or materials for construction projects on which final payment is made directly by the owner will be paid according to terms established in their contracts with other contractors and suppliers.
When can a performance bond be called?
Normally, the issuer of a performance bond will issue it for a fixed term; that is, until all construction work on the project is completed. The issuer will then send notice to the owner and contractor when this time period has elapsed. From that point forward, the contractor must notify the issuer if any changes occur in its financial condition or ability to perform. Otherwise, it could be unable to complete contracted work without forfeiting its entire bid security (for example, cash paid for the purchase of bonds).
The performance bond covers all aspects of contracted work including labor and materials needed to complete construction. However, some states have recently implemented new legislation requiring subcontractors to provide separate payment bonds. Thus subcontractors are now being held responsible for guaranteeing their own payment by others.
What are the benefits of a performance bond?
There are two main types of contractual bonds that can be used to provide security for public construction projects. Performance bonds guarantee the financial ability of a contractor or sub-contractor to complete all phases of contracted work, while payment bonds guarantee that labor and material suppliers will be paid in accordance with their contracts.
The primary benefit of these contracts is ensuring contractors have sufficient funds to complete work on time and according to specifications laid out in bid documents. It also protects owners against total loss if the contractor fails to deliver quality work within budgeted costs. A performance bond ensures that any necessary subcontractors will be paid according to terms set forth in their agreements with other contractors who have already worked on the project.
In addition, performance bonds help prevent problems with the legalities of contract change orders. When a contractor’s financial resources are limited or fluctuate during construction, it can often be difficult for owners to determine how much work will be completed within the original budget and on what terms. In this situation, an owner may choose to make a number of changes to contracted work as specifications continue to evolve throughout the contract phase.
With performance bonds, there is no need for a separate payment bond for each subcontractor or supplier because all payments can be guaranteed by the main contractor through changes in its own performance bond. Finally, these contracts offer protection for public agencies against poor workmanship by contractors who take liberties with state law and bidder requirements when their financial stability is questioned.
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