How performance bonds work
In order to secure a contract, a project owner, who acts as the obligee, may stipulate that a general contractor, who acts as the principal, post a performance bond. In the event that the principal is unable to fulfill their responsibilities, the obligee has the right to request reimbursement from the surety using the performance bond.
These payments are made for damages up to the maximum amount covered by the bond.
In the same vein, a general contractor obligee could demand a performance bond from a subcontractor before awarding the subcontract to the subcontractor. In the event that the principal is unable to fulfill their responsibilities as outlined in the subcontract specifications, the obligee has the right to make a claim against the surety for compensation of damages up to the extent of the performance bond.
It is sometimes referred to as “bonding back” when subcontractors offer performance bonds to general contractors.
Three primary parties involved in a performance bond:
Obligee
The entity that employs or works under a contract with the principal to carry out the task at hand. This is the party that is responsible for providing the specifics of the surety bond need and is also the party that stands to earn financially from any claims that are made against the bond.
Principal
The contractor or commercial enterprise that is responsible for carrying out the construction project. The principal is responsible for paying the initial cost of the performance bond, as well as the expense of having the bond renewed and reimbursing the surety for any claims that are settled against the bond.
Surety
The name of the bank or other financial institution that backs a principal and ensures that its obligations will be met. The surety firm has made a commitment to guarantee payment for all legitimate claims up to the full amount of the surety bond. Sureties are organizations that operate similarly to insurance companies. They, sometimes, function as divisions of insurance companies as well.
Risks involved
Building projects carry a significant amount of inherent danger. Even the smallest of mistakes and delays may result in enormous expenditures for construction businesses and real estate developers.
Performance bonds provide those who invest in real estate the ability to protect themselves from some of the risks associated with their investments. Construction projects are now able to function more effectively and remain economically viable for all parties involved because of performance surety bonds.
It is quite possible that a performance surety bond will ultimately be required of any contractor or company that is engaged in the construction sector. Some are even mandated to acquire brand new performance bonds for each project they participate in.
In addition to that, bonded contractors have a competitive advantage over those who do not have it, which is another reason why bonding should be an important component of your firm.
Applying for a performance bond
The next step is for you to be ready to fill out an application for a bond, which will contain questions about your firm, its finances, as well as its history. You will also be required to submit to a credit check and provide a copy of the conditions for the performance bond that are outlined in the contract.
There is also the possibility that further documents may be required. There may be additional efforts that call for a greater amount of documentation.