Performance Bonds (Surety)
What is it
Bonds can be ‘on demand’ or ‘conditional’, with conditional bonds requiring that the client provides evidence that the contractor has not performed their obligations under the contract and that they have suffered a loss as a consequence. The obligation for the contractor to provide the client with a bond is set out in the tender documents. The choice of bondsman and terms with regard to cost falls entirely to the contractor who secures it prior to the start of work. From a client viewpoint it is wise to stipulate that the bond stays in place until the end of the defects liability period when the final certificate is issued. Bonds can be issued either by an insurance company or by a bank, and the cost of the bond is usually borne by the contractor (albeit, this is likely to be reflected in the contractor’s tender price). The cost of the bond gives the client a good guide as to the credit worthiness and reputation of the contractor in the bond market, which will view each contractor differently in respect of its history, management and financial health. Strictly speaking, the bond is a guarantee and as such is a contingent liability in regard to the contractor’s balance sheet. A smaller contractor might face a limit on how many bonds it can take out.
Performance Bond uses
A Performance Bond is a surety bond issued by an insurance company to guarantee satisfactory completion of a project by a Contractor. For example, a Contractor may be required to post a Performance Bond in favour of a client for whom the Contractor is constructing a building. If the Contractor fails to construct the building according to the specifications provided in the contract, the client is guaranteed compensation for monetary losses up to the amount of the Bond. The Surety will generally bring in a replacement Contractor to finish the project. This type of financial instrument is usually found in the construction or service industry.
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