Construction contractors everywhere have heard the term “Performance Bond”. They’re part of doing business in the construction industry. However, no matter how many of them you may have gotten, or how many times they’ve been explained to you, all you really know is that you need one. But why do you need one? And how can you make sure you’re not overpaying for yours? Are you even sure it’s going to work if there’s a claim taken out on your Surety Bond? Let’s take a moment and look at exactly what a Performance Bond is. This way, you can feel confident that you’re protected and that you’re not overpaying. It’s all part of your risk management program. You do have a risk management program, right? Not to worry, we’ll cover all your bases so you can talk about Performance Surety Bonds like the pro you are.
What are Performance Surety Bonds?
A Performance Surety Bond is a specific type of Surety Bond that is often found when working in the construction industry. All Surety Bonds are technically considered contracts, and Performance Bonds are no different. This particular contract basically says that a party promises to fulfill a contractual obligation as stated by the terms. The terms are the secret sauce of the Surety Bond. The terms state exactly what the bond covers, who it protects, and how much it pays if there is a claim. These terms are one of the four parts of the Performance Bond.
Parts of a Performance Surety Bond
We cannot emphasize enough how important it is to make sure you read the terms of your bond. Make sure that your Performance Surety Bond includes all four parts and that these parts have exactly what you need. As we mentioned before, all Surety Bonds are contracts between three parties. These parties include:
The principal is the party who needs the performance bond to perform the work. They are the ones that will take out the bond and pay the premiums. Other terms for the Principal include Primary, Primary Obligor, or Debtor. It’s important to note that all of these terms mean the same thing. Often, the contractor who wishes to work for the construction company and perform the work becomes the Principal.
This is the company that is responsible for paying out any losses that may incur from a claim against the bond. This party is, more often than not, the surety company that writes and issues the bond to the Principal. They are also called the Secondary Obligor or the Guarantor. This is the party that guarantees the Principal will perform the work. If not, they will cover any losses up to the bond amount. If there is a claim, the Surety has the right to reimbursement from the Principal.
This is the company that received the performance from the Surety Bond. They are typically the construction company or general contractor that is investing in the project. Sometimes they will refer to the Obligee as the owner or creditor. The Obligee has the right to make a claim on the Surety Bond if the Principal does not follow through with the terms of the Surety Bond.
When you check to make sure your Performance Surety Bond is exactly what you need, you need to check with these three parties first. Make sure they list every party and there are no additional parties listed. If, for instance, the construction company tries to add a foreman to the Obligee section, that is an additional person who can make a claim on the bond. It is important to limit the number of people to only the mandatory number. This can help save you money on your rates and prevent the proverbial “too many cooks in the kitchen.” It is also equally important to include all of the principals who will perform the work. This can help balance the obligation of work to all responsible parties.
This is the big one. After you make sure that all the parties are accurate, make sure the scope of work is accurate to your contract. This is sometimes referred to as the Underlying Obligation, Primary Obligation, or Principal Obligations. Everything listed in this section is what the Principal is required to do under the terms of the Surety Bond. If there are things not done to code or not completed at all, they can make a claim on the Surety Bond. The Surety gets the scope directly from the signed contract for work when starting a new project.
What to look out for
Make sure your covered for the scope of, but avoid any secondary obligations. This may be things like providing weekly progress reports, providing notices, keeping files, providing employee or supplier lists, cleaning of work areas, and other small things that don’t have anything to do with the final project’s completion. The easiest way to assure that your surety only includes the important stuff is to create a scope of work document. You can submit this document with your Surety Bond or have the Surety Bond refer to this document. This may require a little negotiation between the Principal and the Obligee, but it’s worth it in the long run. You can save money on your monthly rates for the bond and avoid unnecessary claims against the bond.
What Performance Surety Bonds are Not
A performance Surety Bond is only one of the many tools your company may need to perform work on a project. Other things may include an insurance policy, insurance contract, payment bond, warranty bond, bid bond, or letter of Credit (LOC). These are all separate things that cover your business in other ways. It’s important to look into these as well to cover your entire Risk Management Plan.
Overall, Performance Bonds, like all Surety Bonds, are fantastic tools for risk management. They help your business and, more importantly, give your business credibility. Once you sign your contract, it may be too late to negotiate things like the scope of work and the number of obligees listed on your bond. It is a good idea to go into your negotiations with an idea of your risk management plan so you can include these things in your negotiations.
If you need a Performance Surety Bond, check out SafeLine Surety Bond. They offer competitive rates with underwriters who can get your business protected today! They can get you an instant quote. SafeLine also checks multiple markets in order to get you the best rates. Give them a call and see how much they can save you today.