Differentiating Surety Bonds and Performance Bonds

surety bond - What is the definition of a surety bond - building plan

What is the definition of a surety bond?

A “Surety Bond” is a contract between three parties – the principal, the obligee, and the surety. The principal is an individual or entity requiring protection – usually a business seeking to do business with a state agency. 

The obligee is most often a state agency or municipality, which has requirements that must be met by incoming contractors before it will award them contracts. A surety is an insurance company, which provides financial backing for the contract should the contractor default on its agreement to abide by specific terms of performance outlined in their bond agreement.

The surety promises to pay any claim arising from a default by the contractor up to its face amount; if the contractor defaults on any of its duties, the principal may file a claim with the surety. The obligee has no contractual relationship with either party to the bond, rather it is protected by having an independent third party award compensation for its loss.

What is the definition of a performance bond?

A Performance Bond is a legal agreement between a customer and a surety company in which the customer promises to pay the surety if they fail to uphold their end of the contract. A performance bond ensures that customers will be held accountable for failing to complete contracted terms. 

A Performance Bond ensures your customers or contractors will be held accountable for failing to complete contracted terms if you go out of business.

A Performance Bond also known as a Bid Bond, Contract Bond, Construction Bond, Subdivision Development Agreement is a surety bond that guarantees the faithful performance of the principal under the contracts and/or specifications covered by this agreement. This Agreement serves as a bond issued on behalf of any named Principal(s) who execute it in conjunction with the issuance of a joint performance and payment bond from an approved Surety. 

What distinguishes a surety bond from a performance bond?

A performance bond guarantees that work will be completed in accordance with all legal requirements, with reasonable skill and care by both the subcontractors and employees performing services. 

A surety bond makes up for the loss when there is a default in payment on any debts owed by the principal. This happens because of one or more of five factors: bankruptcy or insolvency, death or incompetency, misrepresentation, duress, or illegality. 

A surety bond protects an obligor against loss in cases where either the principal defaults on payment of a debt or its own negligence results in non-performance. A performance bond guarantees that work will be completed in accordance with all legal requirements, with reasonable skill and care by both the subcontractors and employees performing services. 

What is a surety bond and how does it work?

A surety bond is a guarantee that a certain obligation will be completed. In the context of real estate transactions, surety bonds provide a guarantee that a contracted service will be provided in exchange for money, or that materials/equipment will be delivered in exchange for money.

In general, buyers and sellers make offers to contract services or purchase goods with another company. To ensure these obligations are completed as agreed upon, the contracting parties seek out a surety bond from an insurance company. The contracting parties enter into an agreement to complete their respective obligations by the date outlined in the bond’s terms and conditions. If either party fails to fulfill their obligation, the bond guarantees that they will pay any resulting damages or costs associated with not fulfilling their contractual obligations.

For example, a buyer may contract with a builder to build a new home. The buyer and the builder enter an agreement with each other and seek out a surety bond from an insurance company. This ensures that both parties will abide by their contractual obligations: the Builder must complete construction of the home on time and according to the house plans and specifications outlined in the agreement; and the Buyer must pay for those services as agreed upon.

If either party fails to fulfill its obligation as outlined in the bond, then it will pay any resulting damages or costs associated with that failure as determined by the insurance company via binding arbitration as per terms set out in the bond’s conditions. 

For instance, if there is damage caused by weather conditions and the Builder was contractually obligated to complete construction by a certain date and did not, then the Buyer may file a claim with its surety company. If an arbitrator determines that there was a delay as a result of the weather conditions as defined by the bond’s terms and conditions, then the Developer will be responsible for those costs.

What is a performance bond and how does it work?

One of the most commonly seen requirements for any construction project is a performance bond. A performance bond ensures that the contractor will complete the work specified in the contract, and meet all contract terms and conditions. 

The purpose of a performance bond can be simply stated as “protecting your investment”. As an owner or general contractor you want to know that if something goes wrong on your project, you have recourse to recover some of its losses.

A performance bond protects owners by requiring contractors to carry bonds for 100 percent of their contract price (although many bonding companies require a down payment based upon their underwriting criteria). Bonds protect owners against non-performance: when contractors fail to complete work, do not pay subcontractors or suppliers, or become insolvent—all situations that may prevent them from completing the work specified in their construction contracts.

Performance bonds are available to any contractor, subcontractor, or supplier who is paid by check. However, the surety companies will not issue a bond to any contractor who does not have two years of experience in construction unless they are willing to put up collateral for the bond. The surety company reviews each application to determine eligibility and assigns a rating based on its history with that contractor.

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