WHAT HAPPENS WHEN A PERFORMANCE BOND IS CALLED?

COUNT ON STOKES SURETY BONDS

contractor holding his bid documents for tender date

Brief

Given the current state of the construction and real estate industries, performance bonds are becoming more and more important, as they offer a way of recovering some of an individual’s costs if a contractor or subcontractor becomes insolvent. Unfortunately, you’d likely be surprised at how common this is in today’s industry.

That being said, this is why it is more than important to understand everything you possibly can about these bonds. Whether you are a contractor or an individual, a performance bond will come in handy in a variety of situations.

TOO LONG; DIDN’T READ (TL;DR)

If and when the contractor fails to complete the project as per the outlined terms and within the deadline, the obligee has the right to file a claim against the bond. It is then the surety company’s responsibility to look into this in detail. If the surety company rules in the obligee’s favor, the obligee will be financially compensated. 

WHAT IS PERFORMANCE BOND AND WHEN ARE THEY NEEDED?

As you just learned, a performance bond is a type of bond that offers financial compensation if a contractor or subcontractor becomes insolvent. To learn more about this in detail, please take a look at how does a performance bond work?

These bonds are usually either issued by a financial institution, an insurance company, or a local bonding company like Stokes Surety Bonds. Regardless of what type of entity issues the bond, they all provide a pot of money that can be utilized to finish up specific projects. The amount that they provide will oftentimes vary from situation to situation. However, these types of bonds are usually capped at a fixed rate. A fixed-rate of 10 percent of the contract sum is the norm today.

For instance, if the total price of the contract is 1 million, the coverage offered by the performance bond will be $100,000. This means that the individual or company that required the performance bond will be covered for $100,000 additional dollars. In addition to all of this, it is important to know that performance bonds also usually have an expiration date. This is usually 12 months after the date of practical completion, but this can vary from issuing company to issuing company.

THE PARTIES INVOLVED IN A PERFORMANCE BOND

While there are tons of different types of bonds in the construction and real estate fields, it is the performance bond that really stands out. This is because it offers the protection that is needed to make individuals feel safe when getting work done. That being said, if you want to understand the performance bond, you need to understand the individual involved in the contract. When it comes to performance bonds, there are always three entities involved with the contract. This would be the principal, the obligee, and the surety.

The obligee is the individual, company, or government entity that is getting the work done. This would be the company hiring a contractor. The principal is the contractor or the individual performing the job. This will be the entity involved in the contract that has to apply for the bond. And, last but not least, the surety is the entity that issues the bond. This is usually a financial institution like a bank or a bond company like Stokes Surety Bonds. There are some instances where insurance companies issue bonds as well.

WHAT DOES IT MEAN WHEN A PERFORMANCE BOND IS CALLED ON?

A performance bond is put in place to ensure that a company performs a job to specific guidelines or standards. In a perfect world, these bonds wouldn’t even be necessary, but unfortunately, you do not live in a perfect world. You’d be surprised at just how often these contracts are breached. When something like this happens it can cause major complications. When a contract like this is breached, it is referred to as being called on. While there are a variety of different types of bonds in the construction industry, performance bonds are different.

They are different because they can be called on at any time, regardless of the fault. If you are familiar with on-demand bonds, you likely know that this is not the case. These types of bonds cannot be called on at any time. That aside, the amount of the breach usually depends on the terms of the underlying building contact. Sometimes in these contracts, insolvency in these contracts can lead to automatic termination. 

WHEN CAN A PERFORMANCE BOND BE CALLED ON?

While these bonds are in place to protect the individual requesting the work, they can protect the contractor as well. You’d be surprised at how many times homeowners or government entities try to get free work or extra work out of a contractor. They’ll oftentimes do this by calling on a performance bond when there is no need. Luckily, over the years, surety companies have put measures in place to safeguard against these specific situations.

Now, a performance bond cannot be called on unless there is undeniable proof that the contractor has violated or breached the contract. This means that the individual getting the work done must be able to without a doubt prove that the contractor breached the contract. Calling on a bond is not something that should be taken lightly, as it can have major implications for a contractor. It can cause serious damage to their reputation and hurt them financially.

Along with this, it can hurt the contractor’s ability to acquire such bonds in the future. It might knock them out of it completely or raise their costs of getting such bonds. Think of it as insurance, although the two are nowhere near the same thing. They are, however, somewhat similar in theory.

HOW SOON IS THE OBLIGEE OFFERED COMPENSATION

When it comes to payouts, it is the surety company that pays the obligee if the contractor is insolvent or goes bankrupt. However, the amount will not be paid out until after everything has been properly calculated under the terms of the building contract.

For instance, if the contractor is insolvent, the increased cost of completing the task can only be calculated after practical completion. In these situations, the obligee must submit the claim, but will not be paid until after the job is finished. This is something that will be extremely important to keep in mind, especially when the bond is nearing the expiry date.

As long as everything is submitted before the bond expires, the remedies under the bond are preserved.

DO YOU NEED TO RENEW PERFORMANCE BONDS?

Speaking of expiration dates, performance bonds are not ones that can be renewed. Since they are not tied to contracts, they cannot and will not be affected by the changes in the contract. The bond will only remain in place for the duration of the contract. When the contract expires, the bond will expire.

That being said, there might be situations when the performance bond expires before the contract. In these situations, the performance bond will need to be renewed and can be done so with the issuing party. The surety company will periodically check with the obligee and the contract owner for status on the contracted job.

NEED A CONSTRUCTION SURETY BOND FOR A JOB? COUNT ON STOKES SURETY BONDS