Contract documents

March 27, 2024

Table of Contents

Introduction

Inside a performance bond

Who are the parties involved?

Things to remember

Conclusion

A performance bond is an instrument that mandates a contractor satisfy all of their duties as stated in the construction contract governing a project. Performance bonds are put into place at the beginning of a project. If, for some reason, the contractor fails to complete the project as stipulated in the contract, the owner might have grounds for financial compensation.

Inside a performance bond

No two performance bonds are the same, but the premiums associated with these instruments typically hover around 3% of the contract value. Similar to the driving record of a driver looking to secure auto insurance, performance bonds take several factors into account including:

• Performance history: Performance history includes an organization’s track record on past projects. This history indicates how the organization will perform on the job at hand and helps guide the premium decision.
• Length of operation: Length of operation is another factor that determines the amount of a premium. The longer an organization has been in business, the more likely the premium will be smaller as long as they have a history of responsible operations.
• Credit history: Credit history and scores play a significant role in deciding whether to provide a construction professional with a bond and at what rate. Similar to consumer lending, the higher the credit score, the more favorable the premium terms. Credit checks are considered soft pulls and won’t affect a contractor’s score. Understanding the pull designation is critical as credit plays a major role in the construction professional’s resource mechanism.

Who are the parties involved?

A performance bond involves three different parties. They are as follows:

1. The obligee: The obligee is the client the contractor is servicing.
2. The principal: The principal is defined as the construction contractor who will be primarily responsible for completing the project, regardless of the scope.
3. The Surety: The final piece of the performance bond trio is the company providing the bond to ensure the contractor’s performance, more commonly known as the Surety.

Things to remember

Performance bonds are a must in the construction industry as they provide all parties involved with a measure of protection. With a performance bond, the surety company from which the premium originates covers contractors’ losses, no matter how they originate. This protection applies even in cases where a contractor files for bankruptcy. The one stipulation contractors must be aware of when bankruptcy is necessary is that the contractor must repay any funds disbursed by the surety grantor to the contractor.

The construction industry is becoming more competitive with each passing year, and having a performance bond in place allows contractors to bid on any project where their skill set matches the project owner’s needs. This streamlines the contractor pool, as those without bonds can’t bid, lessening the competition, and increasing the likelihood of bonded contractors securing more opportunities.

Conclusion

When it comes to performance bonds, AIA Document A312-2010 Performance Bond which covers the contractor’s performance is considered to be the industry standard. In addition to contractor’s performance coverage, AIA Document A312-2020 Performance Bond obligates the surety to act responsively to the owner’s requests for discussions aimed at anticipating or preventing contractor’s default.

In closing, performance bonds are a necessary part of the construction industry. They protect contractors and stakeholders, they speak volumes about the operational integrity of a firm, and position all parties, regardless of which side of the table they’re sitting on, for success.

AIA Contract Documents has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors.