Performance bonds have become ubiquitous in the construction industry. In this industry, a performance bond is required for all federal jobs that are larger than $200,000. This is due to the Miller Act. All states have passed similar legislation for state work and these regulations are known as Little Miller Acts. Nearly every municipal government has passes their own legislation that requires a bond as well.
So what exactly is it?
Definition: This is where one party (called the surety) guarantees that the work of another party (known as the obligor) pursuant to the terms of the contract. This guarantee is for the benefit of the owner of the project (known as the obligee).
Let’s look at an example.
The State of California decides to get a road paved. They go publish a request for proposal and get in seven qualified bids. After a good, long bid process, they choose a contractor to pave the road. That contractor, called Smooth as Silk Paving, then has to get a bid bond in the amount of the contract.
Smooth as Silk Paving would then go out and get a performance type of bond from a surety, such as Liberty Mutual, AIG, Philadelphia or someone similar. Given the size of the contract, Smooth as Silk would have to fill out a bond application, indemnity agreement, work-in-process document, three years’ worth of financials (preferably audited, although maybe not required), and personal financial statements. The surety would then take a look and make sure that Smooth as Silk Paving would have the expertise to accurately perform the work according to the contract specifications. For example, Liberty would want to know that Smooth as Silk Paving has completed jobs of similar size with similar paving requirements (such as concrete versus asphalt). In addition, Liberty would be sure to verify that Smooth as Silk Paving has the cash capacity to fulfill the terms of the job and not be caught up in a cash flow crunch.
Once Liberty was assured of Smooth as Silk Paving’s ability and financial position, they would write a performance bond (very similar to a payment bond) to the State of California. This way, California would not have to worry about a road being delayed for years if a dispute were to arise. Instead, California could, in the event of a dispute with the contractor, call upon the bond, which would require Liberty to step in and get another contractor if Smooth as Silk Paving were unable to complete the job.
Finally, there is usually a maintenance period to a performance bond. The maintenance period is simply a time period where the owner would be able to say that the job performed was not adequate (in our example above, if a section of highway collapsed) and the guarantor would have to get that work fixed. This type of guarantee is also known as a contract bond.
There are many types of surety's in the insurance industry. In our next post, we'll discuss contracts that are written on people in the industrial or commercial realm called Fidelity Bonds.
So what exactly is it?
Definition: This is where one party (called the surety) guarantees that the work of another party (known as the obligor) pursuant to the terms of the contract. This guarantee is for the benefit of the owner of the project (known as the obligee).
Let’s look at an example.
The State of California decides to get a road paved. They go publish a request for proposal and get in seven qualified bids. After a good, long bid process, they choose a contractor to pave the road. That contractor, called Smooth as Silk Paving, then has to get a bid bond in the amount of the contract.
Smooth as Silk Paving would then go out and get a performance type of bond from a surety, such as Liberty Mutual, AIG, Philadelphia or someone similar. Given the size of the contract, Smooth as Silk would have to fill out a bond application, indemnity agreement, work-in-process document, three years’ worth of financials (preferably audited, although maybe not required), and personal financial statements. The surety would then take a look and make sure that Smooth as Silk Paving would have the expertise to accurately perform the work according to the contract specifications. For example, Liberty would want to know that Smooth as Silk Paving has completed jobs of similar size with similar paving requirements (such as concrete versus asphalt). In addition, Liberty would be sure to verify that Smooth as Silk Paving has the cash capacity to fulfill the terms of the job and not be caught up in a cash flow crunch.
Once Liberty was assured of Smooth as Silk Paving’s ability and financial position, they would write a performance bond (very similar to a payment bond) to the State of California. This way, California would not have to worry about a road being delayed for years if a dispute were to arise. Instead, California could, in the event of a dispute with the contractor, call upon the bond, which would require Liberty to step in and get another contractor if Smooth as Silk Paving were unable to complete the job.
Finally, there is usually a maintenance period to a performance bond. The maintenance period is simply a time period where the owner would be able to say that the job performed was not adequate (in our example above, if a section of highway collapsed) and the guarantor would have to get that work fixed. This type of guarantee is also known as a contract bond.
There are many types of surety's in the insurance industry. In our next post, we'll discuss contracts that are written on people in the industrial or commercial realm called Fidelity Bonds.