Who needs a performance bond?
First, let’s begin with why we have performance bonds for commercial banks in the first place. What they do is provide an extra layer of protection when failures happen at big, systemically-important financial institutions – banks that are considered ‘too big to fail’.
The idea behind the provisioning of these bonds is simple: if a bank fails, and its bond requirements are insufficient to pay off its creditors, it’s more likely that the government will step in to bail them out. This is an important proposition for taxpayers, because if a bank goes down, then it could end up sticking the taxpayer with a big bill if their bond requirement is swimmingly low compared to what they owe.
What does a performance bond guarantee?
The primary purpose of a performance bond is to guarantee work will be completed; however, this may depend on what type of contract you sign with your potential client. An “x” out fee (penalty) may be required by the client which could include partial payment for services completed.
This fee varies from one client to another and should always be discussed prior to signing any agreements or contracts. A fixed fee or deposit can also act as a performance bond. If the work is not completed, then this fee may be forfeited by the contractor who can also be subject to legal action.
Performance bonds are usually required when a company will be working on government projects or constructing a project that financially impacts a city, county, or state. In order for a contractor to receive a contract from the government, they must show proof of having adequate insurance and their ability to finish the job without going over budget.
This could include a performance bond that guarantees completion of the contract while offering protection to both parties involved in case there are any financial losses or slowdowns throughout construction.
What are the consequences of not providing a performance bond?
The consequences of not providing a performance bond are that the contract is broken. This means that the other party to the contract does not have to fulfill their part of the agreement. They can claim damages against the party who fails to provide their performance bond, which would be intended to reimburse them for all loss or inconvenience incurred by this failure.
For example, if Party A contracts with Party B for $20,000 worth of work and guarantees payment via a performance bond, but then does not place said guarantee, Party C (the counterparty) could refuse to complete contracted work until they are paid in full outside of court proceedings. If there are no other avenues for recourse available to Party C, they may choose instead to stop performing their end of the contract, ultimately ending the agreement.
So in a nutshell, if a party fails to provide a performance bond, that means they have broken their end of the contract and may be liable for damages. This is why it’s very important to understand what you’re agreeing to when signing a contract! Keep an eye out on our blog for our next part of this series covering what happens when a performance bond is provided but not enough surety is given.
Who should have a performance bond?
A performance bond is a contract between the owner of a property and a contractor. The owner can require that an architect or engineer sign off on the project before the contractor starts work.
After reviewing the drawings, specifications, and plan for construction, if an architect or engineer approves of the plans then they will give their stamp of approval on what is called “Form B” which states that they are willing to hold themselves responsible for any additional costs should changes need to be made during construction after work has begun.
Contractors are required to have Form B signed by an architect or engineer before bidding on state highway projects.
Are performance bonds required on all proposals?
The bidder, who provides the performance bond, promises that if awarded the contract he will enter into it and do all things necessary to carry it out. A person with knowledge of the project might not be willing to serve as a surety for the contractor because of his or her concern with its successful completion.
The owner, who requests the proposal, may not obtain insurance coverage until after proposals are received and evaluated because who is responsible for payment cannot be determined until there is actual work involved.
For this reason, an owner should insist on the submission of performance bonds with final proposals so that work on the project can begin immediately upon award without interruption due to the lack of availability of bonding. If the owner has an agreement with a surety to provide performance and payment bonds on new work, it can require submission of such documentation; however, these accounts are pre-paid and unlikely to be available for immediate obligation on any single project.