Contract documents

February 27, 2024

Performance bonds are a cornerstone of risk management in commercial construction projects. They serve as a financial guarantee from a surety (typically an insurance company) to the project owner (obligee) that a contracted party (principal) will perform the work as agreed upon. This article will explore the role of performance bonds and their importance for all parties involved in a commercial construction project.

Understanding Performance Bonds

At their core, performance bonds are designed to protect the owner from the risk of contractor default. They provide a safeguard that ensures the completion of the project according to the terms of the construction contract. The bond amount usually reflects the full contract price and guarantees the owner that the surety will take responsibility for completion of the project, or the provide compensation to the owner up to the bond limit, should the contractor fail to deliver.

The Benefits of Performance Bonds

For project owners, performance bonds offer a level of security that their investment will not be lost if a contractor cannot or does not fulfill their contractual obligations. For contractors, obtaining a performance bond demonstrates reliability and financial credibility to owners, often becoming a competitive advantage when bidding for projects.

The Process of Securing a Performance Bond

The process of securing a performance bond typically involves the contractor applying through a surety agent or company. The surety will conduct a thorough examination of the contractor’s financial records, management experience, historical performance, and the specific project’s details before issuing the bond. This due diligence is a critical step in the surety’s risk assessment.

Cost Implications

The cost of a performance bond, known as the premium, is paid by the contractor, and is often factored into the contract price. The premium can vary based on the contract amount, the duration of the work, the contractor’s financial stability, and the surety’s perceived risk. Bond premiums are often in the range of 1%-5% of the total amount of the construction contract.

Claims Against Performance Bonds

Should a contractor default, the owner can make a claim on the performance bond. The surety then has the obligation to step in to remedy the situation. This could involve financing the contractor to complete the project, hiring a new contractor, or paying the bond amount to the owner. The requirements for pursuing a remedy under the bond, and the surety’s course of action, will depend on the terms of the bond and the construction contract. Federal or State statutes may also come into play.

Performance Bonds vs. Other Bonds

It’s important to distinguish performance bonds from other types of construction bonds. For example, bid bonds guarantee that a contractor will enter into a contract if awarded the bid, while payment bonds ensure that subcontractors and suppliers are paid. All these bonds work together to provide a network of financial security within the construction industry.

AIA Contract Documents offers three industry-standard bond forms and these forms are an important precaution that guard against broken contracts and also strengthen the trust between an owner and contractors.

A310™-2010, Bid Bond: AIA’s simple, one-page bid bond form is used most commonly on public projects. The bid bond establishes the amount due to the owner from the surety should a selected bidder fail to execute a contract per specifications. A310-2010 may also be used by subcontractors when required by the contractor.

A312™-2010, Performance and Payment Bond: AIA Document A312™- 2010 incorporates two bonds—one covering the contractor’s performance, and the other covering the contractor’s obligation to pay subcontractors and others for materials and labor.

A313™-2020, Warranty Bond: AIA Document A313-2020 is an assurance by the Contractor and the Contractor’s Surety that the Contractor’s warranty obligations will be performed and completed in accordance with the terms of the Construction Contract.  Watch On Our Terms short video to learn more about the warranty bond.

Legal Considerations

The legal framework surrounding performance bonds is complex and varies by jurisdiction. Both federal and state laws can impact how bonds are written, and how claims are pursued and handled. It’s essential for contractors and owners to understand the laws, and terms of the bond, that might impact claims and remedies.

Conclusion

Performance bonds play a critical role in commercial construction by providing financial security and reassurance to project owners. They also encourage contractor accountability and help ensure that projects are completed as specified. While there is a cost associated with obtaining a performance bond, the benefits they provide in terms of risk mitigation are invaluable. Contractors often view them not as an obstacle but as a business tool that can open doors to new opportunities. By effectively leveraging performance bonds, the parties involved in a construction project can focus on successful project completion, knowing that they are protected against the uncertainties inherent in the construction industry.

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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.