Performance bonds are typically required for contractors in order to complete a job. A client may hire a contractor for a construction project with the requirement that the contractors enter a performance bond. But what happens when a party violates that bond?
First, it’s important to understand the many facets of a performance bond. There are three main players: the surety, the obligee and the principal. The surety is the insurance company, or surety institution, that issues the bond. The obligee is the client that requires a performance bond while the principal is the contractor who will be performing the work. In a performance bond, the surety guarantees that the project will be complete even if the principal violates the bond or cannot complete the bond.
If a principal is unable to complete the project, the surety steps in to find another contractor to complete the project. The surety also compensates the obligee for financial loss related to the unfinished project. This doesn’t mean the original contractor is off the hook, however.
Repercussions of Breaking a Performance Bond
If a surety has to pay compensation for an incomplete project, the surety may seek compensation in return from the principal that failed to complete the project. This amount could vary depending on the expense of the project. Keep in mind that a performance bond is not the same as a payment bond, though the two often come together. A performance bond ensures a project will be completed while a payment bond ensures that the contractor, or principal, will be paid for their work.
It’s crucial for contractual bonds to be as detailed as possible to the benefit of all parties involved. Vague requirements may not be compensated by the surety if the principal fails to adhere to them. A performance bond is geared to cover the obligee if the principal violates or fails to complete the specific contract in place for the project.
Performance bonds can help prevent lawsuits by guaranteeing compensation to the obligee, but that doesn’t mean it never happens. There can also be repercussions on the business itself for breaking a bond, though this varies per situation.
Keep in mind that contractors may not violate a performance bond intentionally. If the project is not completed according to the initial contract, the obligee may place a claim on the performance bond. In many cases, the surety may attempt to avoid paying compensation.
Who Pays for a Performance Bond?
Another reason a principal should hesitate before violating a bond is that the principal is responsible for purchasing the bond in order to qualify for the contract. Typically, performance bonds are required by government entities and private sectors, who determine all contractors must enter a performance bond in order to protect the company’s assets.
Performance bonds cost depends on the project. Generally, contractors will pay 1% of the contract’s value, but can be more depending on the surety and other factors. For example, if the project is worth $1 million and the contractor must pay 1%, the bond will cost $10,000.
Where Can You Purchase a Performance Bond?
Performance can be purchased through surety companies or insurance agencies. All parties (the obligee, the surety and the principal) should be aware of the limitations and requirements set by the contract being bonded in case of violation. A surety may charge more than 1% for a performance bond based on a variety of factors, including the location, principal’s credit or history and the nature and value of the project under contract.
For help obtaining a performance bond call us today at 817-590-9725