Surety Bond vs Performance Bond
A principal, an obligee, and a surety company are the parties involved in an arrangement known as a surety bond. The surety business is responsible for issuing the bond in exchange for a premium. The obligee will typically agree to the principal’s proposed price or application the vast majority of the time. The principal is often a contractor whose bid has been approved by the obligee on the condition that the principal gets a surety bond to ensure he would fulfill his duties under the contract. The obligee has placed this condition on the acceptance of the principal’s bid.
In addition to that, surety bonds are necessary for professional or vocational licensure by the bodies that are in charge of state regulation.
Surety bonds and performance bonds are two names for the same sort of financial instrument that is used to assist in the definition of company contracts when an owner wishes to employ a contractor to carry out certain activity.
In a broader sense, the phrase surety bond is used to refer to all of these bonds, while the term performance bond is used to refer to a particular kind of surety bond. Payment and bid bonds are two examples of other kinds of surety bonds.
Advantages of Purchasing a Performance Bond
- Offers the property owner options other than cash to address the issues caused by a default.
A Letter of Credit (LOC) will offer an owner the funds necessary to rectify the difficulties that were caused by the contractor’s delinquency, but it will not give them a project that is finished. An owner may have assurance, thanks to a performance bond, that even in the event that the contractor fails to fulfill their obligations, the owner will still end up with a project that has been finished in line with the terms and circumstances of the initial contract.
- Protection that does not intrude.
A line of credit or certified check ties up a contractor’s borrowing line or cash reserves, preventing them from accessing their money and making it more difficult for them to manage their finances during times of financial strain. In a twist of irony, an owner might accidentally bring about the precise situation it is trying to defend itself against by demanding liquid security of this kind.
- Provides an adequate level of protection.
Because LOCs are typically requested in an amount ranging from 10 to 25 percent of the total contract price, this typically results in a shortfall of funds equal to approximately 40 percent of the total contract price. This places the owner in a very difficult position because not only do they lack the funds necessary to cover the shortfall, but they also need to find another qualified contractor to pick up and finish the project.
Making a Claim
The use of surety bonds is an important component of any sound risk management plan for the construction industry. Purchasers and investors in construction projects have a fundamental need for protection against the risks of contractor failure, and surety bonds provide this protection.
In order for owners to take advantage of this protection, they need to understand the requirements that are placed on them by both the contract and the bond, and they need to ensure that they are complying with these obligations. It is a very significant requirement to ensure that the principal has been paid (in a timely manner and in the appropriate manner) for work that has been completed in accordance with the particular terms and conditions of the bonded contract.
When the surety receives a claim that is filed against the bond, they will immediately begin an investigation in order to determine whether or not the claim is legitimate. To put it another way, the surety will make an effort to ascertain whether or not the obligee and the principal have complied with their respective duties as outlined in the contract and the bond.