What are Performance Bonds and How Do They Work
Welcome to the second article in a three-part series on Illinois surety bonds, compliments of guest author Danielle Rodabaugh. Danielle is a principal for SuretyBonds.com and is discussing the three basic types of construction bonds:
● Performance bonds
● Payment bonds
Today we will explore performance bonds.
How Performance Bonds Work
As with other surety bonds in Illinois, performance bonds provide legal and financial protection for those involved in construction projects. When working on a construction project, the contractor secures this bond to guarantee their work and performance under their contract to whomever requests the bond (called an obligee), which is usually the owner, often a government entity, sometimes the owner's lender, and rarely a prime contractor.
In Illinois, the Capital Development Board acts as the obligee, holding the contractor accountable for completing all work properly. The surety agency issues the obligee and sometimes will even act as an intermediary between the contractor and obligee to keep the contract on track. If the contractor does not comply with the contract, the surety is obliged to step-up under the performance bond and perform in the contractor's stead. Performance bonds guarantee that a contractor will perform all aspects of a project according to the contract. If a contractor fails to uphold their end of the deal, then the performance bond will require the surety to fulfill all facets of the contract. The surety could also be responsible for paying up to the bond's full face value (also referred to as the bond's penal sum) for delay damages and other costs incurred due to the contractor's failure to perform.
Regulations Affecting Performance Bonds
Federal, state, and local laws all mandate that bid bonds, performance bonds, and payment bonds be utilized for most public projects. The federal Miller Act dictates the use of surety bonds for all projects in excess of $100,000. Furthermore, the Illinois Public Construction Bond Act requires a performance bond be secured by any person contracting with the state for any public work costing $5,000 or more. Many jobs involving private property projects also take advantage of the protection provided by performance bonds. Some lenders may even insist on them.
Getting a Performance Bond
Once the contract has been awarded, a surety agency will issue the performance bond to the obligee. It's common for the performance bond to be issued in conjunction with the project's payment bond. Failing to secure necessary bonds could disqualify the contractor and result in legal fees and other penalties for the contractor.
Cost: Performance Bond Premiums
Performance bond rates vary for a number of reasons, including the project's total cost and the contractor's credit and financial history. Contractors with good credit and financial history can expect to pay a fee in the amount of .5% to 5% of the bond's full value to get the bond. For example, if the contractor secures a $100,000,000 bond to work on a project, they will pay the surety agency a $50,000 to $500,000 fee. If a contractor fails to qualify for a normal bond, special bonds for those with less than ideal credit can be purchased for a considerably higher fee. Contractors who are qualified can expect to find competitive rates as the bonding industry continues to grow.
Up Next in Construction Bonds
Next Danielle will explain what payment bonds are and how they work.
Construction Law Today is a legal blog about construction contracts, disputes, finance, and the people whose job it is to deal with them.
I'm curious to know why you treat CONTRACTOR as plural in some cases; e.g., ". . . guarantee THEIR work and performance under THEIR contract . . . ."
Isn't THE CONTRACTOR singular?
Thanks.
Is the obligee required to file the construction performance bond as an official record (sealed and recorded with the Clerk of the Circuit Court or comparable comptroller) or can the bond be filed with the general contract papers in the office file cabinet?
Surety bonds assure owners of project completion because a capable contractor one who qualifies for a performance bond is unlikely to default on a project. If a contractor fails to complete a project, the surety bond guarantees compensation for any monetary loss up to the amount of the performance bond
The Government requires performance bonds and payments bonds to protect the tax payer's investment.
The concept of using collateral to obtain a bond means that you give funds, normally in the form of an Irrevocable Letter of Credit, to the surety.