A performance bond is a guarantee for the satisfactory completion of a project. This will require having a collateral property or investment to back up the requirements of the surety agency.
A performance bond is usually issued by a bank or an insurance company, both of which act as a “surety.”
How performance bonds work
The government and private sector require performance bonds and payment bonds for projects to protect the tax payer’s investment. Learn more here about performance bonds.
Common performance and payments bonds for government projects consist of building bridges and roads, although it can comprehend much more than only those two categories.
If the contractor does not complete the project specified in the contract, the surety bonding company will either pay for the completion of the project or hire a contracting firm to complete the project.
A performance bond also protects the owner against possible losses in case a contractor fails to perform or is unable to deliver the project as per established and the contract provisions.
Such compensation is defined as the amount covered under the performance bond.
Also Read: Facts about bid bonds and how they work
Documents required for a performance bond
Insurance and bond companies need different types of paperwork, depending on the cost of the project and its difficulty.
In general, you will need to assemble the following documents before you request a performance bond.
- A copy of the contract
- Completed surety application
- Detailed CPA-prepared financial statements from the past two years
How much do performance bonds cost?
All contractors must likely provide performance bonds to meet contractual requirements.
However, as a rule of thumb, a contractor can expect the cost of a performance bond to be about 1% of the contract value.
More significant contracts are usually around 1 per cent and smaller deals have fewer requirements but are priced at 3 per cent of the full amount.
The performance bond is usually combined with the payment bond under one single coverage.
How can a performance bond help?
This is how a performance bond can help, in case there is a default. Below are some of them:
- Provide financial assistance or extend necessary support to the contractor to allow it to complete the project in full accordance with the contract faithfully
- Engage a new contracting firm to carry out and complete the contract
- Take up the role of the contractor and subcontract the pending work out; or
- Pay in full the amount set in the performance bond as a penalty
Benefits of performance bonds
When using performance bonds, you stand to avoid legal actions that can destabilise your business.
This include charges that come in case you fail to complete the construction as required or within the time frame.
Performance bonds also give you as a business a chance to service many contracts as you are sure of a refund to the obligee in case the project demands so.
This prevents saving many funds allowing cash flow which is critical in business.
This not only ensures growth to your business but also more opportunities thus increasing your network.
Performance bonds also make a business get more asset financing options making the project more successful. This makes it a win-win for both the bidder and the obligee.
Also Read: How to check CRB status online in Kenya
Do not confuse performance bonds for bid bonds
Although the two might sound familiar, they cannot be used interchangeably.
While bid bonds are used while bidding for tender performance bonds are required once the tender has been awarded to a contractor.
Another difference is their purpose. Bid bonds are used to give surety to the obligee that if the contracting company does not sign the contract after being awarded the tender for whatever reason, they will be refunded the amount of the contract up to the next lowest bidder.
Performance bonds, on the other hand, are used to give surety that once the contract has been signed, the contracting company will honour the agreed terms and deliver as required in the contract.
This can be caused due to insolvency or a deficit in the working capital.