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Essential questions related to construction performance bonds

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Before landing a project as a contractor or subcontractor, you should obtain a performance bond. It is a document that serves as a guarantee to the project owner of the contractor fulfilling the construction project on time, as per the contract. With performance bonds, you will be able to land more projects. Here are some related questions that will give you an idea about it.

Why is a performance bond necessary?

A construction performance bond is a surety bond issued by a third party (surety company), who agrees to pay out if the contractor fails to meet specific standards. Although primarily meant to protect the project owner, it is also beneficial for the contractor and subcontractor. It is helpful for contractors who hire subcontractors to complete certain parts of a project, ensuring they complete their task and making a claim against the “subcontractors performance bond” if they don’t.  

What happens if a contractor defaults?

When a contractor defaults on a performance bond, the owner can recover the money from the surety (the party which has issued the bond). The surety broker would also have to provide proof of claim to its client for the amount of the defaulted bond. 

The bond company might also choose to complete the project using the original contractor by giving them financial help. If that is not feasible, they might replace them with another contractor and pay for its completion with an amount more than the one specified in the contract. 

How are these bonds different from insurance?

An insurance policy protects both parties’ interests in case something goes wrong during construction or completion of work. Insurance companies get paid when they make claims on behalf of their clients.

A performance bond is different. If the contractor defaults on a contract or backs out from a project, their surety will compensate the owner financially for the losses. However, the contractor will have to pay the amount to their surety company at a later date under an arrangement called an indemnity agreement. 

How much does it cost?

The total cost depends on the bond, the size of the project, and the contractor. Usually, it costs between 0.5% to 1.5% of the total contract value. The exact range depends on the coverage amount demanded by the owner. If the coverage level is high, it will directly impact the bond’s cost. 

Why should you hire a surety broker?

A surety broker is an expert in construction bonds. They’ll help you with the application and approval process, which are usually complicated. Further, they are in contact with various surety companies and can help you find one that suits your requirements. They will also analyze your financial statements, prepare a submission, try to increase your bond limits, and act as a consultant. 

What documents are required?

  • Application form
  • Certificate of Insurance
  • A copy of the contractor’s certificate of registration
  • A copy of the contractor’s certificate of compliance (for projects that are not within their scope)
  • A copy of the contractor’s certificate of completion (for projects that have been completed)
  • A copy of your building permit for work being done under this bond

These questions related to performance bonds will give you a fair idea about them. Although they protect the owner, they also serve the contractors’ needs. You should contact a surety brokerage company to find a bond suitable for your requirements. 

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