Performance Bonds guarantee for the satisfactory completion of a project. This will require having a collateral property or investment to back up the requirements of the surety agency. A performance bond is usually issued by a bank or an insurance company, both of which act as a “surety.”
Performance Bonds: How They Work?
The Government requires performance bonds and payment bonds for projects to protect the tax payer’s investment. The private sector also requires the issuance of performance bonds. Common performance and payments bonds for government projects consist of building bridges and roads. If the contractor does not completion the project specified in the contract the surety bonding company will either pay for the completion of the project or hire a contracting firm to complete the project.
A performance bond will protect the owner against possible losses in a case a contractor fails to perform, or is unable to deliver the project as per established and the contract provisions. Sometimes the contractor defaults or declares himself in bankruptcy, and then in those situations the surety is responsible to compensate the owner for the losses. Such compensation is defined as the amount covered under the performance bond.
Payment from the performance bond is available only to the project/property owner. No one else can make claims against it. In order for a performance bond to be effective, the contract must be specific about the work to be done. A contractor cannot be held accountable for vague descriptions that are open to interpretation.
Performance Bonds Benefits
Performance bonds ensure that:
- The owner of a project is assured of the completion of the project.
- The owner does not need to incur additional costs.
There are also some drawbacks with the Performance Bonds. The drawbacks of performance bonds are:
- Sometimes, the surety tries to establish that the owner did not comply with the technical conditions of a bond to avoid paying the compensation.
- Sometimes the surety will try to prove, that the owner may have to settle for the least expensive remedy to the problem.
- The owner needs to quantify the losses that might have been suffered when a trader or contractor fails in their performance.
- If the owner underestimates the losses and the future cost of the completion of the project, the owner may not be able to recover the shortfall from the surety.
Performance Bonds Requirements
Surety and financial institutions have different requirements depending on the capacity of the contractor, the volume of the project being ensured and the projects challenges. Usually they ask for the following:
- At least two years of CPA prepared financial statements.
- Copy of the contract that is being awarded.
- Application of the surety.
- If you own real estate, it will help you and will accelerate the process.
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