Construction can be a risky investment, but by requiring a performance bond from the general contractor, the project owner can increase the likelihood of successful project completion. A performance bond acts as an insurance policy for the owner in the event that the contractor does not fulfill the terms of the construction contract. Performance bonds are issued through a third-party surety company that insures the contractor and pays claims to the owner.
A performance bond in construction is sometimes required by a client who wants an insurance policy for the intended work. When a contractor is awarded a construction contract, the owner may require the contractor to post a performance bond to ensure the work will be completed or the owner will be adequately compensated for any monetary damages. The owner can file a claim for damages up to the total amount of the performance. Performance bonds are often standard for public works jobs.
Before acquiring a performance bond, the terms of the bond must be agreeable to both parties. The total scope of work, estimated value of work and the time frame for completion must be determined before bond issuance. Also, the contractor and owner must set forth terms for settling performance issues and filing a claim for the performance bond. The bond issuer will typically define the terms for the performance bond, claims and payment.
The cost for the performance bond is paid for by the general contactor, who usually includes this cost in the company's bid for the project. The cost of the bond depends on a variety of factors, including the total cost of the work and the type of construction being performed. The cost can be anywhere from 1 percent to 5 percent of the estimated cost of construction. If the issuing company determines that bonding the contractor is a risky investment, the upfront costs for bonding will be higher.
Requiring a performance bond is an insurance policy for the owner. Contractors must qualify to be bonded, so the ability of the contractor to acquire a bond assures the owner that the contractor is financially stable and likely to complete the work. The performance bond also assures the owner that if the contractor does not finish the job or takes longer than agreed upon, the owner will be paid adequately for the setback.
A required performance bond puts smaller general contracting companies at a disadvantage for acquiring work. These companies may not be able to afford or qualify for bonding. Other contractors may not be willing to pay upfront for bonding or complete the extra legwork to acquire a bond. This can lead to a decrease in competition among contractors for the owner's project. A lack of competing contractors may imply higher bids for the project. Contractors will also include the bond cost in their bids, leading to higher overall costs for the owner.