Contract Bond vs Performance Bond: Everything to Know
A contract bond vs performance bond serves different purposes such as owner's protection in case the contractor doesn't meet the contract requirements.3 min read
A contract bond vs performance bond serves different purposes. Clients often ask design professionals to help to get a contractor's services to help with construction projects, either by invitation or by a public bidding process. Owners need to know how to protect themselves in case the contractor doesn't meet the requirements for entering the contract or doesn't finish the project according to the specifications and plans that were agreed upon.
A Basic Guide to Surety Bonds
Sureties are a certain segment of the insurance industry that has their own set of rules and procedures for their role specifically. They write bonds that are agreements between three parties:
- Project owner
- Project contractor
While there are varying kinds of bonds, each one is specifically written to guarantee the obligations of certain contracts. Their purpose is to make sure the contractor will perform their duties to the owner, assuming the owner keeps all their promises to the contractor. The most common types of bonds are performance bonds, maintenance bonds, subcontractor bonds, bid bonds, payment bonds, and supply bonds.
Contractors who send in bids often need to give a bid bond as well. This states that the contractor will go into the agreement when it's offered and will provide the required bonding. Bid bonds can be written with a penalty that's equivalent to the contract price percentage, which is 5 percent, 10 percent, or 20 percent. It can also be written with a certain dollar penalty. The claim amount often covers the price difference between the first and second bidder.
If there's a claim, the company will look at the contract to recover its losses according to the indemnity agreement. If the owner decides to offer the contract to the selected contractor and they refuse to agree to it, the owner can make a claim against the bid bond for the price difference of the contract that's in question and how much the penalty bid bond or substitute contract costs, depending on which is less.
The majority of surety companies will file fees or rates for bid bonds, but it's not usual for a surety to demand payment for issuing a bid bond. This is especially true for customers who regularly produce bid bonds. As an example, X School District put out a request for proposals regarding their new high school building's roof. Contractors Y and Z both submit bids to work on this, and the district requires each to send in a bid bond along with their bid. These are purchased from sureties by the contractors.
Contractor Y's bid is accepted, but they think they underbid the project and decide not to go through with the contract or perform any work. In this case, the district can file a claim against the bid bond because the contractor didn't abide by their bid. This type of bond is designed to keep the owner safe in case bidders refuse to go into a contract once it's been awarded or if they withdraw their bid before the award.
Performance bonds make sure the contractor will perform their contractual obligations according to the specifications and plans. The function of this type of bond is to provide protection financially to the owner in case the contractor defaults. The bond company will take on all responsibilities if the contractor doesn't perform their obligations and will assume any contract responsibilities as part of the terms and conditions of their contract. In case there's a default, the bond company can finish the contract by giving any management, technical, or financial support that's required.
They can also find a new contractor and pay for the extra that it will cost to complete the contract, or they can give the owner payment for the bond's total amount. There's an inherent risk with construction work, so it's simple to see why project owners want a guarantee from the performance bond. This bond is looked at as credit for the contractor, and because the company isn't planning on a loss, they'll look to the contractor to recover their claim according to the indemnity agreement.
If you need help with contract bond vs performance bond, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.