Performance bonds are required on all proposals to safeguard the contractor’s promise. Payment Bonds may be worth considering if you’re seeking for a little more security in the event of nonpayment or delayed payment from your contractor.
When is a performance bond necessary?
A performance bond is a sort of contract construction bond that assures the project owner, also known as the obligee, that a contractor will execute a project according to the terms stipulated in the contract. A city, state, or local government, as well as the federal government or a private developer, can be the obligee. These bonds are frequently required for public projects to verify that hired contractors are financially and professionally capable of executing the projects on which they bid. Surety bond businesses who agree to bond a specific company for a project are essentially assessing the contractor’s capacity to complete the project on behalf of the project owner.
The Miller Act of 1934 requires a construction performance bond for federal government construction projects worth more than $100,000. Prior to this, it was typical for contractors to purposefully underbid government contracts in order to win projects, with the goal of not finishing the job unless the contract price was increased thereafter. Obligees were effectively held at ransom because there were no bond sanctions in place to prohibit this. They had two options: pay the higher financial demand or dismiss the contractor and rebid the job, only to have the same problem with the new firm. This problem is solved with performance bonds.
What is the purpose of performance bonds?
A performance bond is offered to one party in a contract as a guarantee against the other party’s failure to meet the contract’s obligations. A bank or an insurance company would normally give a performance bond to ensure that a contractor completes specified projects.
When performance and payment bonds are required for construction contracts, are bid guarantees required?
(a) A contracting officer may not require a bid guarantee unless he or she also requires a performance bond or a performance and payment bond (see 28.102 and 28.103). In the case of building contracts, only individual bid assurances are admissible.
What makes a payment bond different from a performance bond?
Almost all public building work in the United States is done by private companies. Through an open competitive sealed bid system, this work is usually awarded to the lowest responsive bidder. Surety bonds are essential to the system’s operation.
The Bid Bond ensures that the successful bidder will engage into the contract and furnish the appropriate performance and payment bonds, so keeping frivolous bidders out of the bidding process. The owner is protected up to the amount of the bid bond, which is usually the difference between the low bid and the next highest responding bid, if the lowest bidder fails to follow these pledges.
The Performance Bond guarantees that the contractor will complete the contract according to its terms and conditions, at the agreed-upon price, and within the specified time frame.
The Payment Bond guards against nonpayment of certain laborers, material suppliers, and subcontractors. The payment bond may be the only protection these claimants have if they are not paid for the goods and services they give to the project because mechanic’s liens cannot be filed against public property.
Protection By Law
On most public construction projects, bid, performance, and payment bonds are required by law. Few people pay any thought to why these laws were enacted because they have been in place for decades. Some contractors say that the restrictions are discriminatory because they are effectively denied access to public construction projects if they cannot get the needed bonds. Let’s look at what led to the creation of these regulations requiring contractors to deposit bonds when working on public projects.
The federal government became concerned about the high failure rate among the private corporations it hired to complete public construction projects a little more than a century ago. It was determined that the private contractor was frequently insolvent at the time the deal was granted, or went insolvent before the job was completed. As a result, the government was frequently left with unfinished projects, forcing taxpayers to fund the additional expenditures incurred as a result of the contractor’s failure.
Laborers, material suppliers, and subcontractors have no recourse if they were not paid for their work because government property is not subject to mechanic’s liens. The government attempted to use individuals as sureties to safeguard itself and those who worked on its initiatives. Many of these individual sureties, on the other hand, failed to keep their promises, typically due to a lack of financial resources to meet their duties. As a result, in 1894, Congress approved the Heard Act, which authorized the use of corporate surety bonds to secure federal construction contracts that were performed privately. The Heard Act was repealed in 1935, and the Miller Act took its place, mandating performance and payment bonds on all federal building projects.
It’s vital to remember that bid, performance, and payment bonds aren’t meant to protect the people who have to post them. Instead, these bonds are intended to safeguard the project owner from contractor failure as well as certain laborers, material suppliers, and subcontractors from nonpayment.
Assuming The Risk
There are only two methods for carrying out public building. The government can either complete the building contract with its own forces or hire a private contractor to do so.
Which private contractors should the government choose if it hires them? Who are the solvents and who are the insolvents? Those who are technically capable of carrying out the contract or those who are not? Those who will complete the contract on schedule and within budget, or those who will not? Those who will follow the plans and specifications or those who will deviate from them? Those who adhere to safety rules and maintain a safe working environment, or those who cut corners?
The solutions should be self-evident. When seeking work, however, all contractors will state that they are solvent, honorable, and qualified to complete the project. Of sure, some people may be exaggerating.
As a result, the construction project owner would be unwise to choose the first contractor who walks through the door. Obviously, some prequalification screening of contractors is required. The government chose to use the surety mechanism, which means the surety is responsible for prequalification and protects the government from damage if a bonded contractor defaults.
Why The System Works
Despite the fact that there would be no protection for taxpayers, laborers, material suppliers, or subcontractors if there were no bonds, some argue that government officials should prequalify contractors who work on government construction projects. Contractor prequalification by government workers is an unappealing alternative for a variety of reasons.
- Each contractor is distinct, and each building job is distinct. As a result, using strictly objective standards to make solid contractor prequalification judgments is impractical. If a disgruntled applicant challenges a government employee’s subjective choice, the government will find it difficult to defend. This difficulty is solved for the government when the private surety industry is engaged to prequalify contractor applicants.
- Contractors who are turned down by a government official have little recourse but to go to court to seek a different outcome. Suits are both costly and time-consuming. Of course, if the lawsuit is successful, the government will be forced to utilize a contractor it previously avoided. When a contractor is turned down by a surety, he or she may turn to a competitor for a different outcome.
- The taxpayer, not the government official who made the poor decision, pays for the loss when a government prequalifier makes a mistake.
- When the surety commits a blunder, it bears the price. As a result, the surety is forced to make responsible prequalification judgments, protecting the government and taxpayers.
- It is practically hard to prevent contractors from using political influence to gain a favorable prequalification judgment whenever government officials are responsible for determining which private contractors will be permitted to fulfill public contracts.
- When private sector sureties are used, the possibility of corruption is virtually removed.
- Contractors may be hesitant to provide business information with a government prequalifier who is essentially a representative of the construction project’s potential owner.
- Contractors who use private sector sureties send their applications and company information to a third party, the surety, rather than the party with whom they will be contracting.
Summary
The use of corporate surety bonds allows the government to engage private contractors for public construction projects in a competitive sealed bid, open competition system, with the work going to the lowest responding bidder. The government is shielded from financial damage if the contractor defaults, and certain laborers, material suppliers, and subcontractors have a remedy if they are not paid, all without cost to the taxpayer.
Is your performance bond refundable?
To cancel a Performance Bond, phone the bonding business and tell them you don’t need it anymore. When they send you a bond release form, fill it out and return it with your signature.
Is the warranty covered by a performance bond?
Performance bonds are issued to ensure performance, as the name implies. If a contractor fails to meet his or her responsibilities, the surety is responsible for completing the work or paying the owner to do so. But what if the contractor completes the project? Is the surety no longer required? Certainly not. Performance bonds are routinely used by owners to file warranty and latent defect claims. Waiver, expiration of the contractual or statutory limitations period, and failure to satisfy conditions precedent are the principal post-completion defenses accessible to a surety in this article. This article also gives owners and other performance bond beneficiaries some practical advice on how to avoid a surety’s post-completion defenses.
The surety may be able to invoke the common law defense of waiver against a claim on the performance bond if the work is finally accepted by the owner. The owner waives his or her right to file a claim against the performance bond by accepting the work. This defense, however, only applies to patent faultsdefects that are visible to the naked eyenot to latent defects.
Sureties should look into post-completion defect claims to see how and when the issue was found for the first time. Before formally accepting a contractor’s work or making final payment, owners should always take reasonable steps to inspect the job.
Final acceptance by the owner may not result in renunciation of warranty or repair obligations imposed by the contract. This is true as long as the owner notices the faulty work and demands that it be rectified within the contract’s time frame. The surety may be forced to step in if the contractor fails to meet its warranty or repair responsibilities.
Almost all performance bonds on private jobs have a time limit for making a claim on the bond. A frequent time included in several standard payment bonds is two years. The limits term on the ConsensusDocs 260 performance bond, for example, is three years “two years following the Contractor’s default or the Work’s Substantial Completion, whichever comes first.” These forms of limitations periods will be enforced by the courts as long as they are reasonable.
Some constraints are imposed by statute in addition to those imposed by the bond. In Georgia, for example, a lawsuit on public works must be launched within a year “year from the contract’s conclusion and the state’s acceptance of the public work.” 13-10-42 of the O.C.G.A. In Georgia, payment bonds for public works have a similar limits term.
Contractors and owners must be aware of any restrictions periods contained in the bond, as well as any required by statute. It’s also crucial to pay attention to when the clock starts ticking, as it may start ticking sooner than you believe.
At least a few governments follow the theory of nullum tempus regi, which means “time does not run against the monarch.” According to this doctrine, the statute of limitations on a bond does not prevent a government entity from initiating a claim against it after the statute of limits has expired.
A condition precedent is an occurrence that must happen before a contract’s performance is due. Conditions antecedent are commonly included in performance bonds, such as a requirement that the owner declare the contractor in default. There is arguably no responsibility on the part of the surety if such conditions are not met. When the owner hires a substitute contractor, the replacement contractor completes the work, and the owner informs the surety while simultaneously asking for payment, this is a regular occurrence. In that case, it is unlikely that the owner has met the bond’s conditions precedent, and the owner’s claim against the surety may be unsuccessful.
There must be explicit wording establishing that the parties intended to establish a condition precedent for it to be valid. Courts may not imply a requirement in the absence of such unambiguous wording. However, if the court finds an express condition precedent, the court should uphold the intent.
Before the Surety’s responsibility under an AIA A312-2010 bond arises, for example, there are three circumstances precedent that courts have found meet the clear wording requirement and are so enforceable:
- The Owner “notifies the Contractor and the Surety that the Owner is contemplating declaring a Contractor Default…” ;
- “The Owner declares a Contractor Default, cancels the Construction Contract, and informs the Surety; and”
- “In compliance with the terms of the Construction Contract, the Owner has agreed to pay the Balance of the Contract Price…”
However, according to Section 4 of the AIA A312-2010 bond, an owner’s failure to comply with the first condition antecedent has no bearing on the owner’s claim unless the surety can show it was genuinely prejudiced. The AIA A312-1984 bond did not include a requirement for actual prejudice, and most courts did not include such a condition.
Owners asserting post-completion claims have argued that their failure should be excused by futility, that the condition was substantially complied with, or that it was commercially unfeasible under the circumstances where the bond’s conditions precedent are not met. Sureties frequently argue that the bond wording is explicit, and that the surety was denied the opportunity to prevent the default, examine the claim, or select the substitute contractor and the way in which the underlying contract would be fulfilled.
Beneficiaries of performance bonds should read and understand the terms and conditions of their bond. Any and all requirements should be strictly followed, no matter how onerous or fruitless they appear to be.
In cost reimbursement construction contracts, are performance and payment bonds required?
For cost-reimbursement contracts, performance and payment bonds are not required. However, for cost-type contracts with fixed-price construction subcontracts above $40,000, the prime contractor must acquire the following performance and payment safeguards from each of its construction subcontractors:
(1) Payment protection adequate to pay labor and material expenses, utilizing any of the alternatives indicated at FAR 28.102-1(b) for fixed-price construction subcontracts over $40,000 but not exceeding $150,000. (1).
Are service contracts subject to bonds?
Construction comes to mind when most business owners think of organizations that require performance and payment bonds. However, janitorial, street sweeping, window washing, security guard, and other service providers are increasingly being forced to post public works bonds.
Bonding should be considered ahead of time by service companies that work for public owners, rather than waiting until a specific RFP calls for it. While the bond’s actual substance is the same, the underwriting is not.
In addition to the company’s financial qualification for the bond, a service company should expect its bond agent to resolve contract difficulties indicated in the RFP. Two of the most important issues are:
- Contract duration Because many service contracts are multi-year, this is typically the most difficult hurdle to overcome. A performance bond guarantees the entire contract, and surety companies, on average, do not want to be tied to a contract for more than two years. Some property owners will accept an annual bond form as a solution to this problem.
- Renewal/non-renewal clauses For service contracts with renewal options, some owners provide the owner, principal (contractor), or surety the choice to renew. This is the best case scenario. Other owners prefer complete confidentiality, which might make obtaining a bond difficult.
Many service contractors are unfamiliar with the bonding process and aren’t prepared to bond until they’re faced with a tight deadline. The greatest strategy is to start a bond program as soon as possible. When a bond is required, it costs nothing and saves time and trouble. And it will become increasingly necessary.
What is the difference between a performance guarantee and a performance bond?
Because the word “performance bond” is frequently misunderstood, contractors may be unsure of the distinction between a performance bond and a performance guarantee. The majority of building Performance Bonds are Guarantees. Bonds and guarantees are related, but they are not the same thing. The right to make a claim under a Guarantee is contingent on the underlying contract’s failure to fulfill. A bond is typically paid on demand by the bank, regardless of the underlying contract.
Performance Guarantees given by insurance firms and Performance Bonds issued by banks are commonly accepted by project owners.