The Definition of a Payment & Performance Bond

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Performance bonds govern contractor and owner relationships.
Performance bonds govern contractor and owner relationships. (Image: construction image by Oleg Gribanov from <a href='http://www.fotolia.com'>Fotolia.com</a>)

A performance bond, also known as a payment and performance bond and sometimes as simply a surety bond, is a special type of contract created when someone hires a contractor to carry out a construction project. The bond helps makes sure the requirements for the project are fulfilled. It is not a form of insurance: The bond is only a contract tied to a certain sum of money required from the contractor and is not a policy with automatic coverage.

Definition

A payment and performance bond is a type of contractual guarantee offered by a contractor to the owner of a property or asset for a specific project that the contractor is willing to do. The bond ensures that the contractor will complete the project as specified, or face serious default penalties. Many organizations, including the government, require performance bonds when they choose a contractor to work on projects.

Parties

There are three parties in a performance bond. The first party is the principal, or the contractor who is hired to do the work. The second is the obligee, or the owner who requires the work to be done and has already specified project details and payment. The third party is the surety company, usually an insurance company or lender that creates the bond with the principal and handles communication and costs between the contractor and the owner.

Process

A performance starts out as a bid bond. Every contractor bidding on a project offers a bid bond. When an owner chooses a particular contractor and the contractor enters into an agreement with the owner, the bid bond becomes a performance bond and focuses on the project itself. When the project is completed, the performance bond is fulfilled and ends.

Benefits

A performance bond makes it much easier for owners to trust contractors. If the contractor fails, the contractor must make payments for any costs incurred out of the specified monetary amount of the bond, including the costs for finding another contractor. Contractors who create performance bonds must be sure they can fulfill the details of the contract, which helps build trust on both sides.

Considerations

Performance bonds are legal documents, and their importance depends on their wording, especially in terms of the exact way the owner wants the project completed. If there is any contest to the meaning of the bond, the surety company investigates, at expense to the contractor. If the owner wants to make any changes to the bond, then a request must be made to the surety company well ahead of time.

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