Who needs a performance bond?
We hear the term “performance bond” and we think of great works of art like paintings and sculptures, contracts for show business, and other entertainment industry ventures. It’s all very glamorous. The truth is that performance bonds are actually extremely common in many types of construction projects that you might not normally associate with such a bond (and certainly don’t expect to need such a bond).
General contractors usually require subcontractors to give them an acceptable form of security guaranteeing their ability to complete a project should they fail before it’s done. This requirement often takes one of two forms: an Indemnity Agreement or a Performance Bond.
What does a performance bond guarantee?
A performance bond guarantees that if a contractor defaults on its responsibility under the contract, an insurer will pay for any losses directly related to the defaulted work. The bond also requires the insurance company to pay the claimant’s legal fees if litigation is necessary to recoup these damages.
Performance bonds are sometimes also called bid or payment bonds because they guarantee payment for work done on construction projects. They usually ensure $100 per $1000. So if you have a $500,000 contract and need a $50,000 payment bond, you would expect to pay about $2700 for your bond (because it’s 5% of your contract amount). The good news is that many companies offer discount rates if you’re getting multiple bonds or bonding large contracts; this can significantly reduce how much your performance bond actually costs.
Performance bonds are often required of: subcontractors, suppliers, and lenders who do business with a contractor. They’re called for by the owner (the person you’re contracting with) or general contractor using an “itemized list” of subcontractors on the project. If you don’t know if your contract requires one, ask your general contractor to be sure. This is important due diligence you’ll need to do in order to get your job done.
What are the consequences of not providing a performance bond?
If you’re a subcontractor, supplier, or lender who has agreed to provide goods or services for a building project and fail to complete the work or meet your obligations on time, the general contractor may make a claim against your performance bond insurance. If there’s no payment bond posted by you (the sub, supplier, or lender), you could be personally liable for the difference of what the contractor loses as a result of your failure.
You should also know that if you demanded the owner post a performance bond on his/her contract with you (often called “piggybacking”) but they refuse to do so, then they might not have adequate funds to pay for any work completed by yourself AND thus be in breach themselves… which entitles you to pursue them for the money you’ve expended trying to make their project succeed.
This is why “good faith deposits” are often required of contractors – the owner/general contractor knows they’re likely to set off a chain of events that can easily result in him being sued if he defaults on his contract with you, so they’ll try to protect themselves by requiring your good faith deposit – which is the amount of money you must pay them into an escrow account to ensure that they’ll complete their end of the deal.
The bottom line is that if you’ve been asked to provide a performance bond, it’s because there’s a significant chance that failure of yours to perform your contractual duties will result in the loss of money to the party that requested it.
Who should have a performance bond?
If you are any of the following, it is advisable for you to get some form of payment or indemnity bond:
A subcontractor on a building project. A supplier of goods or equipment used on a project. A lender providing money for a project.
You should always speak to your insurance broker or agent about what’s right for your business and the steps you can take to protect yourself from financial loss on projects where you’re providing goods and services.
Not providing a required performance bond may result in an owner’s termination of your contract, which could stop work on your project altogether. This could mean that you forfeit any progress you’ve made to date and potential losses for you. As a result, it’s best to find a performance bond company that can help.
Are performance bonds required on all proposals?
No. You should ask your client or contact at the project site if a performance bond is required on their contract with you. Performance bonds are usually necessary when a subcontractor, supplier, or lender may not complete the work they have agreed to perform for a fixed price or premium – but not always.
When working with a new client, it’s important that you find out upfront if a payment bond is required by them as part of your contractual agreement before you start work on their project. This will help prevent any delays in getting started and provide peace of mind that all bases are covered from both ends.
Performance bonding requirements can vary widely from state to state and even within different divisions within states. For reason, it’s best to check with your client or contact at the project site before you start providing goods and services for them – this way there’s no chance of delay in getting started.
