Surety bonds are commonly used in the construction industry and are designed to act as a form of guarantee. When a contractor’s work is covered by a contract bond, for example, the principal can be sure that they will be compensated if the work is not completed.
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In essence, this is exactly how construction performance bonds work. The site owner or property developer is the principal who hires contractors to complete the work. The two parties negotiate a contract, which is usually highly detailed and complex. A key clause in the contract will be that the contractors obtain a performance bond prior to the contract being signed.
If the contractors do not complete the work in accordance with the terms of the contract, the performance bond acts as a sort of insurance. The principal can claim then recoup their losses from the performance bond company or provider.
However, a performance bond won’t simply cover any losses the principal incurs. Instead, contractors stipulate how much they want the performance bond to cover when they buy it from the construction bond company. As part of the contract, however, the principal may stipulate a minimum amount that the performance bond should be worth, as this ensures there will be sufficient financial compensation if the contract is not fulfilled.
How much is a construction performance bond?
The cost of obtaining performance bonds varies depending on the specific requirements. In general, however, a performance bond will cost around the equivalent of 1% of the project value. When the project value exceeds £1 million, it is not unusual for the cost of performance bonds to increase to 1.5-2%.
Of course, the nature of the project and the contractor’s financial history will also have a bearing on whether the surety provider will offer them a bond and, if so, at what price. As insurance firms and construction bond companies can set their own prices and rates, it is important that contractors find the lowest fees possible, as this reduces their expenditure.
At the same time, however, it is essential that any construction bond provides sufficient coverage. If a proposed performance bond is not deemed to be comprehensive enough, the principal will simply disregard the contractor’s attempts to negotiate. While obtaining a low-cost performance bond may be beneficial for contractors, accessing a cost-effective performance bond from a reputable provider is far more advantageous in the long-term.
What are the advantages and disadvantages of performance bonds?
Performance bonds are widely used throughout the industry as they provide principals with the reassurance that
- The project will be completed in accordance with the contract terms
- They will not have to provide additional funding
However, there can sometimes be limitations or disadvantages associated with performance bonds. For example
- Contracts must be sufficiently detailed so that it can be determined whether the contractor has fulfilled the terms
- Bond providers may try to argue that the contract has been completed when the principal believe otherwise
- The principal may be required to quantify any losses they have suffered
- The terms of the surety may mean that the principal is forced to use a specific remedy to complete the project, usually the cheapest option available
From a contractor’s point of view, obtaining performance bonds can be time-consuming and arduous. As construction bond companies and insurance firms will want to see a range of documentation and run credit checks prior to offering a bond, the process can delay contract negotiations. Furthermore, contractors may be required to spend time comparing contractors bond providers to ensure they get the best rates, prices, and fees.
When do you need a construction performance bond?
When projects are being funded, at least in part, by the taxpayer, a performance bond is essential. This ensures that taxpayers’ funds aren’t wasted, so it is a critical component for these types of contracts.
However, the use of performance bonds is widespread throughout the construction industry. In reality, the vast majority of construction contracts will include performance bonds, regardless of whether taxpayer funding is being used.
Even private companies and investors will generally rely on performance bonds to protect their interest in a project. Due to this, contractors must be able to obtain competitive performance bonds if they want to operate in the industry.
What other types of construction bonds are there?
Although construction performance bonds are widely used, they aren’t the only type of bond or surety which is relied upon. In fact, there are various different types of bonds used in the building trade.
Payment bonds, for example, provide a surety that relevant parties will be paid for the work undertaken, in accordance with the contract. This prevents unpaid parties from placing a lien on the completed project and having an ongoing interest in the property.
Although payment bonds can be obtained individually, they usually accompany a performance bond. In some cases, insurance firms and construction bond companies will include a payment bond with a subcontractor performance bond, although the exact terms are dependent on the contractor’s specific requirements.
In addition to this, bid bonds are used to guarantee that a contractor will complete the work in accordance with the bid they have submitted. This stops contractors from winning contracts by entering low bids and then increasing their price further down the line.
Obtaining construction bonds
As the use of contract bonds, bid bonds, and performance bonds is so widespread throughout the construction industry, any company that wishes to operate in the sector will need to be familiar with them. For contractors, their commercial success and project suitability will be partly dependent on their ability to secure appropriate bonds.
Of course, it is in a contractor’s interest to obtain the bonds required for as little outlay as possible. To ensure you can obtain the bonds you need as the most competitive price, why not use a trusted surety agency to find you the bonds you need.
At Pinnacle Surety, we work tirelessly to ensure you have access to the best rates and sureties. To find out more, contact our team today on (844) 612-7238.
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