When trying to complete a construction project, many things could go wrong. This is because there are various parties involved in a construction project, and any mistake from one stakeholder may hamper the deadline or deliverables of the whole project.
As a project owner, it is in your best financial interest to safeguard yourself from loss. Many project owners have made it mandatory for their contractors to provide a performance bond.
While these bonds are necessary for government projects of over $500,000 in some states, many private firms are also asking for performance bonds from their contractors.
Such bonds provide a surety to the project owner that they would not have to suffer losses if things go wrong.
Performance bonds are used in most industries, but most commonly, you would find them being used in construction industries.
But, what are performance bonds?
It is a type of guarantee for the project owner stating that the contractor or the service provider will ensure the timely delivery of the project and will also ensure that they have delivered the best quality of work as agreed in the contract.
A financial institution issues performance bonds upon checking the various credentials and requirements of the contractor. After the financial institution has performed its due diligence, they issue the bond.
Once the bond has been issued, the project owner is protected against any contractor’s shortcomings. So, if in case the contractor has declared bankruptcy or delivered inferior quality services, the surety will be liable for it. The project owner may receive compensation or reimbursement from the surety as per the terms and conditions of the bond.
Types of bonds used in the construction industry.
1. Bid bond
If you are a project owner, you will invite tenders from contractors and other service providers. They will submit their quotations and other details as mentioned in the tender specifications.
As the project owner, you have the authority to deny or accept any tender or bid you might receive.
The purpose of a bid bond is to ensure that the quotations mentioned in the bid are accurate, and the contractor will provide other bonds such as a performance and a payment bond when their bid gets accepted.
In simple terms, a bid bond helps the project owners assess the accuracy of the bid.
2. Performance bonds
Performance bonds promise the quality of work a contractor will deliver within a stipulated time frame and conditions as per the original contract.
This safeguards the interest of the project as they get an assurance that the work will be completed timely and in the manner that was agreed upon. But, if anything goes wrong, the surety will take care of it.
The surety ensures that the project does not have to face losses because of the contractor. In many cases, the performance bond is issued for only fifty percent of the contract’s value, but it is for the hundred percent of the contract’s value in many cases.
Moreover, the surety would be liable to the extent to which the performance bond was issued.
3. Payment bonds
Unlike the other two bonds, this bond ensures that the contractor would pay their dues to their suppliers and labourers.
When the contractor pays their dues to their subcontractors and other involved parties on time, it will ensure that the project is completed on time and the quality of work is up to a point.
It also prevents the project owner from being liable to subcontractors on behalf of the main contractor.
Benefits of construction bonds
- These bonds are primarily used to protect all the vested parties from a financial loss. All the project owners and investors can be assured that even if the contractor fails to provide quality or deliver on time, the surety will cover some of the contract value. This protects them from a total loss.
- If the main contractor fails to pay their subcontractors or labourers, it could cause a delay. But, such bonds ensure that the main contractors have to pay all the parties under them. Moreover, it waives the accountability of the project owner towards any of their subcontractors.
- By making such contracts mandatory, project owners can enjoy a better quality of work from the contractors. A performance bond makes the contractor more accountable as every promise is under a well-charted contract that will have consequences if not followed. This makes the project owner more vigilant when doing the job.
These are the common types of construction bonds used in a project. While they are not mandatory, incorporating the various construction bonds makes it easier for the project owner to manage the project.