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Commonly asked questions about performance bonds
Construction work is challenging, tedious, and quite complex. No matter what you are constructing; a home, apartment complex, or a road, there will be many challenges in your way.
Moreover, there are a lot of contractors involved in a construction project which can make it difficult for you to manage the project.
Besides, the major issue is quality assurance. There is a lot riding on the quality of work done by the contractors. When the project is of high value, it is essential to have some guarantee or surety by the contractor regarding their quality of work.
Any mess up from the contractor’s end can further push the project’s deadline or cause tremendous losses.
In such cases, performance bonds are issued as they safeguard the financial interests of all the parties and ensure that the contractor does their work as per the agreed-upon terms and conditions.
Here are some of the commonly asked questions about a performance bond.
1. What is a performance bond?
It is a legal instrument that puts the contractor under a legal obligation to fulfill his promises as per the original terms and conditions. A performance bond safeguards the project owner from any mishappening or mistake from the contractor’s end.
In many cases, you will see that these bonds are issued for fifty percent of the total contract value, but in some rare cases, the bonds are issued for even thirty percent of the contract value.
But, project owners can even ask for a hundred percent of the contract value to be covered under the performance bond.
However, many people often mistake a performance bond for insurance. Unlike insurance, a two-party agreement, a performance bond is between the project owner, the surety, and the contractor.
A simple written agreement or a contract can not be called a performance bond as it has to be issued by the proper authorities to be enforceable.
2. Who requires a performance bond?
Many industries require a performance bond, but in Canada, it is required when dealing with publicly funded or government projects exceeding the value of $500,000. Most commonly, performance bonds are issued for construction activities, and in some cases, they are required in service-based projects. Many project owners have started specifying and making a performance bond mandatory in their tender requirements.
For instance, snow removal contractors, tree cutting contractors, and janitorial and landscape contractors require a performance bond.
But, the use of performance is not limited to construction as it can be applied to any service-based or performance-based industry as it is even used in industries like trucking.
3. How many parties are involved in a performance bond
A principal, obligee, and the surety are the three parties involved in a bond.
Firstly a principal is referred to the person applying for the performance bond, and in most cases, it is the contractor applying for a tender for a project.
In this case, the obligee is the project owner or the person to whom the contractor is supposed to provide the agreed-upon deliverables. Earlier, these performance bonds were only used for government projects, but now, more and more private companies are reaping the benefits of a performance bond. So, an obligee could be anyone, and it could be the government, a private firm, or even an individual getting some renovation done to their house.
Lastly, a surety is a person who takes a guarantee on behalf of the contractor and assures a specified percentage of the total contract amount to the project owner. The surety is commonly a financial institution that takes a certain amount as their fee from the contractor to issue the performance bond.
4. How does it work?
If there is any contract breach by the contractor or the service provider, the obligee can file a claim as per the conditions set in the initial contract.
The claim can be raised with the surety, and they have to deal with the obligee.
A performance bond safeguards the project owner if they declare bankruptcy, provide sub-par quality of work, or if the contractor has exceeded the promised time in completing the work.
When the obligee raises a claim, the surety might pay them for the cost of the remaining project or might reimburse the obligee in a different way as per the set terms and conditions.
5. What is the cost of a performance bond?
The cost of the performance bond solely depends upon the cost of the contract and other terms and conditions of the contract.
It is either one to two percent of the overall contract in many cases, but the fee may be more or less depending upon each specific case.
A performance bond is a beneficial tool that helps safeguard a project owner’s financial interest as it protects them from overspending on a project because of a contractor’s shortcomings.