There are many types of bonds and one such type is called a contract bond. You may have heard of this especially when it involves construction or big industrial projects. This is because construction projects involve contracts between the contractor and the project owner.
Contract bonds help assure the project owner that a project will be fulfilled regardless of what the contractor does. You can look at it as a safety net in case the contractor does not do his part of the contract. These things are needed so that in an unfortunate event, the project owner can go after the bond to recover all finances put on the project or construction. Contract bonds are often done before starting a public project. However, private projects can also create contract bonds to ensure their finances.
There are several types of contract bonds but performance bond and payment bonds are the most common among all of them. These two may sound the same, but they guarantee different things.
A performance bond guarantees that a project will be fulfilled. It is a type of surety wherein the project owner is assured that the project will be completed even if the contractor fails to perform his end of the contract. This type of contract bond happens between the project owner (whether public or private) and his contractor. In addition, you should take note that a performance bond can also be issued for delivery projects. Say for example, you want a huge amount of raw materials to be delivered. A performance bond is created so that the buyer will still be compensated if ever the raw materials will not be delivered. Performance bonds are usually issued together with payment bonds and that is why both of them are very popular.
Payment bonds, on the other hand, guarantee that labor and materials are covered in an event that your contractor defaults. When the contractor is not in his capacity to pay for the materials and labor, the project owner can then use this money to pay for those. Like what was said earlier, a payment bond is usually issued together with a performance bond.
However, this is different from a mechanics lien because mechanics lien is quite the opposite. The latter guarantees the contractor, supplier, or any person offering the service that their services given will be paid. A mechanics lien is usually done on repairs and constructions to give assurance to the contractor or subcontractor that they will be paid. To add to that, a mechanics lien usually does not restrict contracts involving public properties, so a payment bond is necessary instead.
If you are still a bit confused with the two, all you have to look at to know the difference is who the bond is benefitting. A performance bond benefits the project owner as their interests are secured for the project that the contractor may not fulfill. In contrast, a payment bond benefits the subcontractor and the laborers if ever the contractor cannot pay for them. The payment of materials and human labor should not fall under the project owner so this bond is created to avoid this instance.
But no matter how different these two contract bonds are, their goal is the same – it is to provide assurance both to the project owner and the other parties involved in the transaction. For a construction project, these bonds are supposed to protect other parties that the contractor’s business and conduct might affect. Unfortunate things can happen and these bonds can help in preventing additional costs to be paid by the project owner.
Just imagine if your contractor suddenly abandons you in the middle of constructing your house. What are you supposed to do? If you don’t have these bonds, your claims to your finances and the payments you’ve given to your contractor will not be supported. What’s worse is that you would have to spend twice as much to cover for your contractor’s actions or lack thereof. These instances are not uncommon so it is best if you take the safer option and get bonds issued to protect your interests. For both contract bonds, you would be creating a contract between you, the contractor, and the surety. The surety is an insurance company that is licensed by the state where your construction or transaction will take place.