Should You Ask For A Performance Bond?
February 24, 2009
The question that worries most owners who are thinking of hiring a contractor is, “What if the contractor doesn’t finish the project?” After all, horror stories abound regarding contractors who go out of business during a project or who simply disappear halfway through. And these nightmares can still occur despite the owner’s best efforts to check the contractor’s reputation and references.
One way to avoid such a fate is to ask for a performance bond.
What is a Performance Bond?
In construction law, a performance bond is essentially a guarantee that the contractor will finish the project on budget and schedule. The guarantee is made by a surety company – a corporation licensed by your state to make such financial promises. If the contractor is unable to finish the project, then the surety company will step in to make arrangements for the project to be completed as expeditiously as possible for the original agreed-upon cost.
Does a Performance Bond Protect Against Construction Defects?
A performance bond does not directly insure against construction defects. In fact, once the project is completed, the bond is automatically cancelled. In an indirect way, however, a performance bond can help prevent construction defects from occurring by:
- Assuring that your contractor has a certain degree of professionalism and competency
- Avoiding disruptions to the project that can contribute to construction mistakes.
How Does a Performance Bond Work?
Although a performance bond brings great peace of mind, surety companies rarely ever actually take over a construction project. That’s because the greatest value the surety company provides is investigating the contractor’s background, reputation, and financial strength before approving the bond. In fact, the majority of the bond fee is for paying for this investigation.
In essence, a surety company issues bonds only to contractors they can rely on. So if your contractor is unable to get a performance bond, it’s a sign that something may be amiss. Granted, some very competent contractors who are new in business may have difficulty getting a performance bond only because of a limited track record. Should that disqualify you from hiring one of them? That has to be your choice. But if professionals in the business are unwilling to bet their money on him, should you?
What Does a Performance Bond Cost?
If you do ask your prospective contractor for a performance bond, he may ask you to pay for the cost. If he doesn’t, he still has to include the cost in his bid, so you’ll end up paying for it one way or the other.
The fee for the bond varies from one-half percent to two or three percent of the contract value. On a $100,000 contract, that could be as much as $3,000 added to the cost. Is it worth it? As with any insurance-type product, you have to be your own judge of the value of peace of mind.
What If I Need to Make a Claim?
Given the surety company’s vote of confidence in your contractor, it’s very unlikely you’ll need to know about claims. If you and your contractor get into some sort of disagreement, however, filing a claim may cross your mind. So there are a few things you should know.
Be Sure You’ve Done Your Part
The contract between you and your contractor includes your obligations as well as the contractor’s. If the contractor is unable to finish or the cost goes up because you’re not performing your responsibilities, the surety company cannot help you.
Understand What Default Is
The surety company is not going to referee your disputes with your contractor. The surety does not step in until after you have formally declared the contractor in default. Typical reasons for declaring the contractor in default are:
- The contractor breaches an important term or condition in the contract related to the work – such as failing to make progress as promised.
- The contractor fails to pay subcontractors or suppliers according to terms.
- The contractor abandons the job or voluntarily defaults.
Start a Claim Investigation
If you’ve performed all your responsibilities and you suspect your contractor is not going to be able to complete the project according to the contract, notify the surety company. They will begin an investigation to uncover the facts. If the facts indicate the problem is correctable, the surety will let the owner and contractor know what needs to be done to get the project back on track.
If the facts indicate the contractor is genuinely in default, then you must formally declare the contractor in default via the notification method spelled out in the contract.
Work with the Surety to Finish the Project
Depending on the terms in the contract and the surety’s preference, they may:
- Take the contractor’s place in the contract and hire another contractor to complete the project.
- Hire another contractor who contracts directly with the owner.
- Allow the owner to complete the project.
In any of these cases, it is the surety’s responsibility to complete the project at the original cost, with adjustments for change orders as appropriate.
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- How to Chose a Contractor
- Questions to Ask Your Contractor Before You Sign
- Shady Contractors: Warning Signs to Watch For
- What Does Contractor Liability Insurance Cover?
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