Contractors are required to offer a number of bonds when they bid or work on any project. These can be construction bonds, bid bonds, performance bonds, payment bonds, maintenance bonds, license bonds, labor, and material bonds. These bonds allow contractors to bid for and execute projects and is applicable to both government and private projects.
These surety bonds act as a financial guarantee, and for those contractors who are able to provide such bonds, it greatly increases their credibility and enhances their chances of getting projects. A performance bond is issued by a company the provides surety bonding or an insurance company. There are rules that govern the issuing of such bonds. There are three parties to any performance bond. The contractor who undertakes the obligation of performance also called the principal; the obligee or the party who will get the benefit from the bond; and the underwriting insurance or bond company that guarantees the obligation. A performance bond in most cases will cover the full value of the contract.
The difference between insurance and a performance bond is that the provider of the surety looks for a guarantee from the entity asking for the performance bond. In this way, the principal guarantees payment to the surety provider and may look to cover this by asking for assets as collateral, and personal bonds from the principal or his or her associates. Besides this, they are also required to give a lot of other information that will satisfy the surety of the financial soundness of the entity asking for performance bonds. It includes the latest audited annual financial statement of the company applying for the bond, a financial statement of the year, including cash flows, historical audited statements of the last three years, bank credits and other financial tie-ups, a reference from the banker, inventories of all works being undertaken at present, cost and accounting controls, and even personal financial statements of the owners of the company applying for the bond.
The surety provider will also require the applicant for the performance bond to provide information about the project for which the performance bond is required, past experience with similar projects, details of labor to be employed and subcontractors capabilities, equipment that will be used, a project management plan, and a summary of all past and pending projects and whether they have been provided similar bonds. They may also ask for details of future planned projects, a plan for the continuity of the company, and for a resume of all the owners of the company. They can also ask for details of lending institutions providing the company with finance, the details of the owners of the project for which the performance bond is required, and may require details of all suppliers and subcontractors.
The premium for a performance bond can vary from 0.5% t 2.0% of the contract value and will get adjusted upwards if the value of the contract escalates. Even after the premium is paid, bond underwriters will oversee the performance of the project in great detail, so that they can spot any factors that are a cause for concern.