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Performance Bonds in Construction – Explained!

Performance Bonds in Construction – Explained!
  • PublishedJuly 20, 2022

Construction companies undertake large projects, and to ensure proper completion of the tasks assigned to the contractors, they need a specific agreement that acts as a guarantee. 

Construction performance bonds are a type of surety agreement that involves a third-party guarantor who is the surety. It is signed to prevent the obligee, the client, or project owner, from any possible financial losses caused by the principal, the contractor.

The contractors use the performance bond to complete a project for the owners and confirm that the quality of the project will be as per their requirements. At the same time, the agreement saves the owner from any loss of money if the contractor misses their due mark or compromises on the quality of the work performed.

How Does it Work?

The bond works just as any other third-party financial security contract does. It forms a legal tie between the principal (the contractor) and the obligee (the client or the project owner) in the presence of a professional surety or guarantor. This deal strictly works for quality standards, due dates, unfinished work, low-quality work, or failure to provide satisfactory results. 

It mainly protects the money of the project owner because they have a lot of money at stake. Consequently, these are often used for large-scale private projects or government work. If the contractor or the principal fails, the guarantor will compensate the obligee and ask the principal to reimburse the outstanding amount. 

It is important to note that the construction performance bond was made after the Miller Act in the United States. It is mandatory for all public project contracts worth $100,000 and above. However, the contract is optional if the project cost estimation is below. The agreement is crucial because it ensures that every entity involved in the project will be paid in full for their workmanship, supplies, or contractors.

Difference Between Performance Bond and Bank Guarantee

Performance bonds are often confused with bank guarantees. However, they differ from each other. 

Claims

Both the agreements have different claim types. Performance bonds for construction firms can be claimed when the principal fails to perform as per the obligations. The guarantor will provide compensation for the losses and issue an amount for another contractor to complete the work.

On the other hand, the bank guarantee is all about the contract obligations. If the party does not fulfill the contract, the guarantor must pay the guaranteed amount to the winning party.

Contract Types

The agreement is tied up with three entities. First is the obligee (the owner of the project or the client of the contractor), second is the principal (the contractor who is taking up the construction project), and third is the surety (the guarantor who is, in most cases, a bank). 

However, the bank guarantee is between a financial institution and the client who wants to get an assurance that their money won’t be lost if the contractor terminates the project or there is any loss. 

Conclusion

Construction performance bonds are a fantastic solution to assure that your finances are not lost in case of any fault by the contractor. That is why they are being mandated for large-scale projects, and government construction works.   

 

Written By
Jenny

I am the content writer for Allblogsidea, where I love what I do. Writing is my passion; it's what drives me in life. It makes me happy when people share their stories with the world so they can be heard.