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If you’re in the construction business, there’s a very good chance you’ll need to obtain a performance bond at some point. But what is a performance bond, and who needs it?
A performance bond, with bondable meaning indicating that it’s an insurance policy, guarantees that the contractor will complete a project or contract as agreed upon. Construction companies typically use it, but other businesses can require it. If you don’t know whether or not you need a performance bond, read on for more information.
Understanding The Basics Of A Performance Bond
According to Investopedia, a performance bond is usually provided by a bank or an insurance company to ensure a contractor completes designated projects. A performance bond is a kind of insurance that protects the interests of the party who hired the contractor (owner or lender).
To obtain a performance bond, businesses must usually meet specific criteria. For example, construction companies must have a good credit history and may be required to provide collateral.
The prerequisites for obtaining a performance bond vary from company to company. Some of the basic ones are explained in detail here:
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a) The Contractor Must Have A Good Credit History
A credit history contains information about a company’s ability to repay its debts. It is usually assessed by looking at the company’s credit score. A high credit score means the contractor is likely to be reliable and trusted to complete the project.
b) The Contractor May Be Required To Provide Collateral
Collateral is an asset or security offered to guarantee that the debt will be repaid. If the contractor cannot complete the project, the party who provided the performance bond may take possession of the collateral.
c) The Contractor Must Agree To Specific Terms And Conditions
Before a company can be issued a performance bond, it must agree to specific terms and conditions. These usually relate to how the project will be completed, the schedule, and what happens if the contractor fails to meet the deadline.
Who Needs a Performance Bond?
Now that you know what are contract performance bonds, the next step is to discover who needs them. Not every business is on the lookout for a performance bond. So, you must do your research and find out if you’re required to have one. Here are some general guidelines:
a) Businesses That Deal With Construction
The construction industry is highly regulated, and most states require contractors to obtain a performance bond before starting working. It protects the party who hired the contractor from any potential damages or losses.
b) Businesses That Deal With Government Contracts
Government agencies typically require businesses to work with them to obtain a performance bond. It protects the government from financial losses if the business fails to complete the contract.
c) Businesses That Have A High Risk Of Not Completing A Project
Some businesses are more likely to fail chances than others. If your business has a record of failing to complete projects, it’s highly likely that you are asked to provide a performance bond.
For example, a construction company that has a history of not completing projects may be required to submit a performance bond.
d) Businesses That Are New To The Industry
If you’re starting a business, it’s essential to be aware of the potential risks involved. One of those risks maybe not being able to complete a project. As a result, new construction companies may be asked to include a performance bond as part of the contract.
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Things To Check Before Obtaining a Performance Bond
Now that you know the answer to “What is a performance bond?” you can go ahead and obtain one.
However, there are a handful of things you must check before you put in an application. Some of them are explained here:
a) Check The Bonding Company’s Reputation
The bonding company you choose is important. Make sure to do your research and read reviews before applying. You want to be sure that the company is reputable and will help you if you run into any problems.
b) Confirm That You Meet The Eligibility Requirements
Not every business is eligible for a performance bond. Make sure you meet the requirements of the bonding company before applying.
c) Have A Detailed Contract In Place
For the bonding company to approve your application, you need to have a detailed contract in place. The contract should outline the project, the schedule, and what happens if the contractor fails to meet the deadline.
d) Check the License and Insurance Requirements
Different states have different license and insurance requirements. Make sure you are aware of what’s needed to complete the project. You may need to provide a performance bond to obtain the necessary licenses.
e) The Project Is Well-Defined
The project you’re undertaking must be well-defined with specific deadlines and milestones. It will help to avoid any confusion or misunderstandings down the road.
Final Thoughts
A performance bond is a surety bond that guarantees the contractor will complete the project outlined in the contract. Government entities or large companies often require this type of bond. It can be costly, but it is a necessary safeguard for those who need it.
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