Performance Bond

A performance bond is a guarantee that an employer would receive compensation for a project that is left uncompleted by a service provider.

These types of financial requirements and arrangements are justified as an employer can potentially incur great financial losses due the delay or abandonment of projects by service providers who were hired to complete them.

Performance bonds are most often observed in the building and construction industry where contractors are signed up for undertake and complete huge development projects.

Because a lot of money is at stake, magnifying the potential losses for incompletion, employers can make performance bonds a requirement when inviting builders to tender for construction projects.

When the government invites applicants to tender for land slated for sale, bidders are also required to have submit documents pertaining to performance bonds or form of guarantee together with the tender documents.

These can also be known as bid bonds or performance guarantees which serve as security deposits.

Such bonds can also be demanded by property owners who are hiring builders to build their own homes. But contractors might find that providing such guarantees are not worthwhile unless the project involves a big amount of money.

Issuers of performance bonds

Performance surety bonds are typically issued by insurance companies and banks.

This is why they can also be categorized as a type of insurance policy. They also sometimes known as contract bonds.

In the case of the latter, it can also be in the form of a banker’s guarantee.

Both a performance bond and banker’s guarantee would financially protect an employer in the same legal manner.

To obtain a performance bond from an insurer, the applicant would usually need to provide documents to submit with their applications like:

  • Financial statements for the most recent 3 years
  • List of past completed projects
  • List of current projects
  • Collateral being put forward (if any)
  • Special conditions to include in the bond
  • etc

It is also from the assessment of these documents and the requirements desired by an applicant that a premium can be placed on the bond instrument.

The amount guaranteed usually don’t exceed 10% of the contract sum.

Two types of performance bonds

There are two types of performance bonds.

  1. Conditional bonds
  2. Unconditional bonds

Conditional bonds don’t allow the a beneficiary to call on the bond unless some specific events occurred as agreed by both parties when negotiating the agreement.

For a call to happen, the employer has to proof that a condition was met and that it constitutes a breach of contract. Thereby, legitimates the call on the performance bond.

Unconditional bonds give the employer more power in calling for payment. A developer is not required to provide evidence that there was a breach of contract in order to make claims from the third party insurer.

This is why they are also sometimes referred to as on-demand bonds.

However, should there be no justification for an unconditional bond to be activated, then the aggrieved party can bring the case to court and obtain an injunction for the action claiming an abuse of contractual terms.

If a court finds favor with the request for injunction, the employer can still sue the contractor for damages.

In the past, such contracting relationships between employers and builders require the latter to place cash deposits with the former.

This would be like a security deposit a tenants places with the landlord. And that money can be drawn upon for specified reasons.

But that practice has become old-fashioned as performance bonds can play the same role as cash deposits, but allow contractors to keep their cash as working capital to use for their operations.

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