Construction Business Management


Performance Bonds Guarantee Clients Receive Exceptional Service

The use of performance bonds in the construction industry has grown steadily over the past few decades, yet many contractors still have a limited understanding of how exactly they work and why they're required. A performance bond is a specific surety bond type that's used frequently on construction projects, especially those that are publicly funded. This article will answer some common questions contractors have about performance bonds, whether they've been working in the industry for years or have just recently become licensed.

What is a performance bond?

The term "performance bond" comes from the bond's legal language that requires contractors to perform their jobs as contracted. Each performance bond issued brings together three entities in a legally binding contract.
  1. The principal is the contractor who purchases the bond to guarantee the quality of work performance.
  2. The obligee is the entity that requires the bond, which is the government agency other individual funding the project.
  3. The surety is the agency that provides a financial guarantee of the contractor's work by issuing the bond.

If a contractor fails to perform according to contract, then the obligee can file a claim on the bond. If the claim is found to be valid per the bond's contractual language, then the surety provider that executed the bond will release the bond's funds, which typically pay for a second contractor to come in and complete the job. Oftentimes surety providers underwrite bonds to include indemnity agreements in which the contractor agrees to reimburse the surety if a financial loss should occur.

What are the benefits of performance bonds?

They protect consumer interests. Unlike insurance policies, surety bonds do not benefit policyholders. Rather, surety bonds protect the interests of others. In the case of performance bonds, the project owner that's paying for the job receives protection.

They regulate the industry. All contractor bonds, including performance bonds, enforce existing laws that regulate the construction industry. The laws reinforced in a bond will vary depending on the city, county or state requiring the bond.

They hold contractors to higher standards. Performance bonds keep unqualified contractors from gaining access to certain markets and jobs. The surety bond process requires a neutral third party — the surety — to evaluate contractors before they can become bonded. Contractors who don't qualify for bonds cannot work on certain projects.

Who needs a performance bond?

The federal Miller Act mandates the use of separate payment and performance bonds for all publicly funded construction projects that exceed $100,000. However, more specific laws at the state or local level could mandate their use on public projects that cost much less. Although performance bonds are not legally required for privately funded projects, anybody funding a project can require one as a way to guarantee financial protection if the contractor should fail to complete the project. So, to summarize, contractors need a performance bond if
  • they will be working on any publicly funded project that exceeds $100,000
  • a state or local government agency has a lower contract threshold (i.e. contractors in a specific city might need a performance bond for any project that exceeds $10,000)
  • any private project owner chooses to require one before work can begin on a project.

How do contractors get a performance bond?

Contractors can fill out a performance bond application online in just a few minutes. Before issuing the bond the surety will conduct a thorough review of the contractor's financial credentials and work history. Once payment has been received, the surety will issue the bond to the contractor. Individual contractors or construction professionals who operate small firms can get bonded through the Small Business Administration's Office of Surety Guarantees if they don't qualify for a performance bond from a commercial provider.

Although performance bond benefits are numerous, the process contractors have to undergo to get one can be stressful. To lessen the stress, contractors need to give themselves ample time to get one rather than waiting until just a few days before the due date.

Danielle Rodabaugh is the editor of the Surety Bonds Insider, a publication that provides in-depth analyses of developments within the surety industry. The Insider explains contract bond changes to help contractors understand the surety bond regulations that apply to them, whether they work in New York or California.


RSS Feed

Member Comments

Post Your Own Comments 
» Not a member? Register now to become one. Otherwise, login to post your comments on this article.

click here to update your log-in and member information

click here to maintain your company profile & view metrics