InvestingBytes.com

A bank or insurance company issues performance bonds to provide a surety toward the completion of a project on behalf of the contractor. These bonds are usually backed with an investment or collateral property in order to back up the issuer’s agency.

In general, a performance bond or payment bonds are drawn in lieu of both the government and private sector projects that ensure the protection of the taxpayer investments involved. In the case of a government contract project that involves the construction of a bridge or roads, these performance bonds ensure the bond issuing institution pays up for the project completion if the contractor drops out mid-way, or get a replacement contractor who will complete the remaining project.

An owner’s interests are essentially protected by these performance bonds in the face of the contractor’s failure to abide by the contract provisions in completing the project. A compensation is drawn out in favor of the owner if he is about to suffer a loss due to the contractor’s failure, or if the contractor steps outs of the project by claiming bankruptcy.

The payment of performance bonds is limited to the claims of the project or property owner, and any third-party is restricted from the claim of such payments. A legally binding performance bond should contain specifics of the project in detail so that a contractor cannot be held responsible in case of ambiguity in the bond.

Cost of a performance bond: It is generally difficult to provide the exact cost figures of a full project at the time of bidding, and at most times the performance bonds cannot list out certain unpredicted costs that could happen during the course of the project. However, one of the primary contractual requirements of most projects are these performance bonds. Hence, as a thumb rule, performance bonds are issued at just about 1% of the total value of the contract. In the case of big investment projects, this base insurance amount can vary based on different criteria. The general practice is to combine the performance bond with the payments bonds in order to protect the insurer’s interests.