Purpose of a Performance Bond
A performance bond is a special type of bond used when people hire contractors to complete projects. There are many variations to a performance bond, and they hold a unique place in the financial world. They should not be confused with security bonds, which are a type of investment--performance bonds have nothing to do with investments. They should also not be confused with insurance, although they are more similar to construction insurance without the premiums.
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Definition
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A performance bond is an agreement between the person who owns the project and the contractor who agrees to complete the project. The contractor agrees to do the work and finish the project at a certain time, while the owner of the project agrees to pay the contractor at a certain time. If the contractor does not fulfill this bond or backs out of the project, the bond compensates the owner for the loss of time and materials.
Purpose
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Performances bonds are used by owners who are not sure that they can fully trust their contractors, and want a safety net that will pay them back if the project goes wrong. With a performance bond, owners can specify exactly what kind of work they want done and hold the contractor to it. Government agencies and larger corporations require performance bonds for this reason.
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Parties
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There are three parties in every performance bond. The first party is the contractor who actually creates and pays for the bond. The second party is the performance bond agency, which makes the bond official and inspects the project if either side has a complaint. The third party is the owner, who signs off on the bond and pays the contract, but has no relation to the performance bond agency.
Benefits
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Performance bonds allow contractors to win large-scale jobs where they are required. They are a useful tool for encouraging trust between two parties who do not have experience working together. The owners clearly benefit from the bond, and contractors can establish a relationship with bond agencies that allow them to easily work together.
Considerations
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Performance bonds are not like insurance: the contractor must pay all expenses out of pocket, including any costs associated with the inspection of the project and the costs that reimburse the owner for wasted time. This can add up and be devastating for a contractor, so contractors must be very sure of their ability to complete a project before offering a performance bond.
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