In the construction industry, performance bonds serve as a guarantee that the contractor will finish the project correctly and satisfactorily. As a contractor, you must know the details about performance bonds to protect your business.
A performance bond is issued by a surety (often an insurance company or a bank) and guarantees to the project owner or manager that you will meet your contractual obligations. The surety typically requires collateral, which can include real estate or other investments.
After you obtain a performance bond, you are expected to complete the construction project as specified in the contract. If you fail to perform, the bond issuer may pay the project owner and then seek repayment from you.
Who needs a performance bond?
Contractors working on private-sector or government projects commonly need a bond for each contract to guarantee completion and protect owners from financial loss. For projects that involve both completion and payment obligations, owners often look for additional protections such as Performance and Payment Bonds.
Documents required to request a performance bond
Insurance and surety companies require documentation to evaluate risk. Preparing these items before you apply will speed the process.
- A copy of the contract
- A completed surety application
- Detailed CPA-prepared financial statements for the past two years
Bond cost is usually a percentage of the contract value. For large projects the rate may be around one percent, while smaller contracts can carry higher percentages.
Your creditworthiness, the type of work, and the state where the project is located also affect the premium. Include the bond cost when preparing your project bid.
What happens after the performance bond is cashed?
If you do not meet your contractual obligations, the project owner can file a claim against the bond. The surety investigates the claim and, if valid, pays the owner up to the bond limit so the project can be completed.
Only the property or project owner may receive payment from the bond, and the owner can use that money to hire a replacement contractor or finish the work. If the surety pays a claim, you remain responsible to repay the surety, typically from collateral or other funds.
Performance bonds protect project owners and help ensure they receive quality work as outlined in the contract. If you have questions about applying or coverage, consider contacting a surety specialist or ask an agent.
Frequently Asked Questions
Do all contractors need a performance bond?
Not all contractors need one, but many owners and government projects require performance bonds as a condition of the contract.
What kind of collateral is typically required?
Collateral can include real estate, liens, or other assets depending on the surety’s evaluation of the contractor’s financial strength.
How long does a performance bond remain in effect?
The bond usually remains in effect for the duration specified in the contract, which often extends until final acceptance of the project.
Will a claim on a bond affect my ability to get future bonds?
Yes, a paid claim can make it harder or more expensive to secure future bonds until the claim is resolved and your financial standing improves.