Why Performance and Payment Bonds are Crucial

Construction business is risky. Many construction firms face the possibility of being out of business because of several reasons. These reasons range from an economic downturn, labor issues, equipment, and material problems and a host of other problems which can cause stagnation of projects. Construction project owners, both public and private should, therefore, not gamble when it comes to hiring a construction company. They cannot guarantee that the company will deliver its part of the bargain without a hiccup happening somewhere in the middle of the project. 

Public agencies mostly choose low over high bids when determining which contractor will land the job. It, therefore, gets harder to assure quality and dependability. That is why project owners need to have a type of surety bond called a performance bond. 

What is a surety bond?

A surety bond is a bond that assures a project owner that the contractor will complete their project successfully. The bond acts as a promise to project owners that contractors will perform the required work and pay all parties involved. These include laborers, subcontractors, and suppliers of materials. There are many types of surety bonds, including bid bonds, performance bonds, and payment bonds. A performance bond protects the owner of the project from financial losses in case the contractor hired does not deliver according to specifications outlined in the contract. A payment bond secures the payment of workers within the construction.

Parties to surety bonds

There are three parties to a surety agreement. The first party is the principal who will perform the contractual obligation and pay premiums to cover the surety bond. The second party is the obligee, who is the person or company under protection. The third party is the surety who guarantees the obligation. 

For most government agencies or private agencies to hire a construction company, the company must have a performance and payment bond. The most common government projects for which surety bonds are vital are bridge and road construction projects. If a construction company fails to complete a project, the surety bonding company will hire another firm to complete the project or pay the existing construction company for the completion of the project.

What makes for effective performance and payment bonds?

A contract must be very specific for a bond to be effective. It must state the terms clearly and expressly because the contractor will not be liable for vaguely described work that can leave room for a variety of interpretations. The performance contract should entail the period of the contract, that is, the date it begins and when it ends. It should also have the name of the project owner and the contracting company. Most importantly, it should detail the range of services and equipment that the contractor should provide. It should also provide the terms of payment.

Other issues that the contract also needs to address include cancellation policy for both parties, the relationship between the two parties, that is, it should state whether it is an employment contract or not. There should also be clear mechanisms for the resolution of any disputes that may arise during the term of the contract.

How to estimate the cost of a surety bond

A contractor bidding for work may find it difficult to determine how much the performance bond will be worth. As a rule of thumb, you can go for 1% of the contract value. The premiums paid will vary depending on the creditworthiness of the builder. The payment and performance bond can fall under one coverage.

Some drawbacks of surety bonds

The burden of quantifying losses suffered when a contractor fails to complete a project lies with the project owner. Estimating the losses and the cost that will be adequate to complete the project in the future is crucial. If the owner underestimates the cost, they may find it very difficult to recover. 

Sometimes, the surety also tries to establish that the owner violated the technical conditions of the bond so that they can avoid settling the compensation. They may also create arguments to make the owner settle for the least costly remedy to the contractual problem. As a project owner, you, therefore, have to very particular about the details of the contract to ensure that you comply. 



Disclaimer: This content does not necessarily represent the views of IWB.


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