Area of Law: Construction Law
Answer # 1986
Performance BondsRegion: Ontario Answer # 1986
A Performance Bond, also known as a surety bond, contract bond or construction bond is a legal agreement issued by an insurance company. Performance bonds protect construction project owners by guaranteeing that the contractor will complete the construction project in accordance with the terms of the contract.
What types of construction projects require Performance Bonds?
Performance Bonds are most often required for government projects (including municipal, provincial and federal), but private property owners can request them as well. They are not available for consumer home renovations.
When a contractor becomes a successful bidder on a job, a Performance Bond must usually be submitted before the project can begin.
How do Performance Bonds work?
A Performance Bond is a legal agreement among three parties:
- A Surety: the person or company who takes responsibility for the project if the contractor defaults,
- A Principal: the contractor or construction company, and
- The Obligee: the project owner or party responsible for hiring the contractor.
If the contractor defaults on the contract (also known as a breach of contract), a Performance Bond ensures that the project will still be completed or the owner will be compensated.
Who buys Performance Bonds?
Insurance brokers and banks sell Performance Bonds to the individual or construction company who is completing the project, including general contractors and subcontractors.
What if the contractor defaults?
If the contractor defaults on the contract (usually because of lack of funds or project mismanagement), the Surety will assume responsibility of the contract subject to the conditions of the bond. The Surety generally has four options:
- Remedy the default – A remedy could include providing the contractor with the money needed to complete the project, or replace the contractor’s management.
- Complete the contract with its own contractors – The surety can enter into a contract with the owner, whereby the Surety can hire its own contractors to complete the project. This is often the best option when the project is close to completion and providing financing to the defaulting contractor to complete the project is not an option.
- Complete the contract with a different contractor (re-tender) – The project owner will enter into a new contract with a replacement contractor to complete the defaulting contractor’s obligations. In this case, the Surety will absorb the additional costs for the tender process and any other costs charged by the new contractor that are above the original contract amount.
- Pay the bond penalty to the owner – The Surety will pay:
- the additional cost to complete the project, or
- the amount of the bond, whichever is less.
For more information about performance bonds, or to purchase a bond, contact Ai Surety Bonding.
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