A Performance bond provides a financial guarantee for the completion of commercial or construction projects. The bond provides a guarantee that the principal (you) will complete the task which has been given to them or to their company by the owner of the project, who is the obligee. The obligee can be a governing body, municipality or a private owner of a project. When the bid is placed, the price, time frame and the standard level of the project is mentioned by the principal. The payment bond provides a guarantee to the obligee that the project in hand would be completed as per the agreed terms. However if the principal (you) defaults or is not able to continue with their job for any particular reason, the performance bond can be cashed by the obligee in order to recover from any losses. The principal may be the one who is responsible for any losses which have been incurred by the insurer or the surety. It is important to understand that the Performance bond comes after the bid bond. This bond is only workable when you have won the job or the project on the bid which you placed. It only comes into effect when you are 100% sure that the project would be awarded to you only. There are no upfront expenses.
The benefits of Performance bonds
Fixes the problem
While a letter of credit (LOC) will only provide the owner the money which can be used in order to fix any problems which may be created by default by the contractor, it will not give them a completed project. A Performance bond on the other hand, provides the owner with peace of mind. Even if the contractor defaults the owner will still have a completed project as per the terms and conditions of the original contract.
Protection from first dollar loss
The Performance bond provides the owner with complete protection from the first dollar of loss and the owner does not need to take responsibility for deductibles or co payments.
The letter of credit are generally called for the amount of at least 10-25% of the amount of the contract which means a shortfall of funds (usually around 40% of the price of the contract) can leave the owner in a tricky position. This would mean, not only do they have the funds to cover the cash shortfall but the owner must now also find another contractor which is qualified enough to finish off the project where it was left off.
Non intrusive protection
A certified cheque or an LOC tie up the borrowing line or the cash reserves of the contractor and it denies them any sort of access to their money even in the times of financial shortfalls. Ironically, by providing liquid security, it may inadvertently create the problem that it means to protect itself from.
What the Performance bond is not
Not a source of quick cash
These are not liquid instruments which can provide cash on demand and instead, it seeks to provide the owners with what they had contracted for, which means a completed project.
Not a tool for dispute resolution
The Performance bond provides protection to the owner’s financial interest, in case the contractor defaults in their contractual obligations. It is not a tool which can be used for the resolution of any disputes which may arise between the contractor and the owner during the construction process. Any disputes of such a nature should be addressed by remedies and mechanisms which are provided in the contract.
Not a quick fix for everything
The Performance bond can really go a long way to provide protection and solving complex problems but it cannot be considered as a quick fix or a miracle cure for every construction related issue. For example, if there is a messy default which occurs on a project which is complex, there will surely be a lot of delays and possible lengthy ones. The surety would have to sort out the issues and arrange for a contractor for the completion of the project or someone who can finish the left over project. It is important to know that such issues can arise irrespective of the bond. The owners are generally encouraged to provide support to the bonding company and work with them in order to help the job to successful completion.
How to apply for the Performance bond
The process of applying for a Performance bond is quite easy if you follow these simple steps mentioned below:
- You have to ensure that your company is fully set up and is active with a surety company as well.
- You have to provide your broker with the award letter which you receive from the owner of the project which you will be undertaking. This is always given to you when your company is selected for the work. The confirmation of winning the job may also be verbal.
- You have to inform the broker the number of days that the bond is required in; usually it is within a week where you have to present the bond.
- You have to make the payment for the bond premium.
- The delivery instructions have to be specified, as many companies prefer to have the bond couriered to them, while other prefers to meet the broker in person.
3 ways the bond may be presented
The bond becomes effective when you win a bid or you get hired by the person or the company/municipality/governing body, etc which is known as the “obligee” and they may want to have the bond presented in three possible ways
- 50% of the total job
- 100% of the total job
- 50% of the performance and 50% of materials and labor which totals up to 100% of the total job
You would know what is required even before placing the bid. All information is presented in the tender document which contains all the specifications of the project and other details. From that point onwards, all you need to do is to tell your broker what is required for them to do so that the bonds are prepared correctly. One thing however should be kept in mind which is that you have to factor in the cost of the total bond in your bid, as the cost of the bond should not be an additional cost for you. That is why you need to take the quote for the bond before you make the bid.
How is the Performance bond cost determined?
It is very important to know what would be the cost of the Performance bond but the bond is only required once you know for sure that you will be doing the required job. The bond is surely worth the money as it helps to save you on your working capital and other hassles of arranging alternative guarantee for the obligee or the owner of the project. You should however still be aware of what types of different contractual bonds which are there and factors which can be important in determining the total price. Some of the factors are:
- The bond amount in total
- The type and size of the contract
- The province of the contractual obligation
- The surety company
- The credit and history of the contractor
- Fees for the brokers and the agents services
The financial statements which are required for performance bond
In order to obtain a performance bond, the company’s financials of the past three years are required. There are many companies which may still provide the bond but you may end up qualifying for the small limit program. Many other companies may ask the contractor for additional documents especially if they require a bond where the limits are higher than the regular ones. The additional documents which may be required are:
- The company’s balance sheet
- The income statement
- Cash flow statement
- The work schedules
- Their current jobs
It is very important to have a performance bond when you are undertaking new projects as it will save you time and money and risks, associated with delays. All property dealers, especially who are in Canada, must obtain a performance bond or a contract bond for all of their property development projects. It helps to protect yourself, your company and your investment against possible risks.