Features

• A performance surety bond is simple. The person who hires a contractor is called the "obligee," and the contractor he hires is the "principal." The obligee forwards money to a bank or insurance firm, the "surety," during the contract negotiations with the assent of the principal, usually something close to the total cost of the project. If the project is not completed, or not completed on time, both the principal and the suerty are responsible for the money, called the "penal sum," to compensate the obligee. The surety can sue the principal for the money, since they are both equally responsible to the obligee.
  
  

Function

• The purpose here is not insurance. This is not an insurance policy. It is an amount of money that becomes the nexus of the agreement among the bank, contractor and owner. Once the project is completed, the bond is null and void and the money goes back to the owner. The ultimate purpose here is to provide peace of mind to the owner, especially for large and expensive projects. In the final analysis, if the contractor/principal does not finish the job, it is he who is responsible.
  
  

Significance

• The basis of the surety agreement is that contractors must be obligated for their projects. A contractor must pay a premium to the surety in order for the bond to go into effect. Being cooperative with such agreements is essential to the financial health of a contractor: No one wants to hire a contractor who refuses these agreements or has reneged on them once a project has begun.
  
  

Premiums

• Banks or insurance firms issuing the bond are concerned with the history of the contractor as well as the total cost of the project. Contractors with a good reputation can pay as little as .5 percent of the total bond up front. Contractors with a bad reputation can pay as high as 20 percent of the penal sum up front. It is in the contractor's interest to remain loyal to the bond, and to do so regularly.
  
  

Benefits

• The benefit of this bond is that it forces contractors to stay close to the project and see it through. Contractors who are irresponsible are not issued bonds, or they are issued bonds at a very high rate. This means the system has a filter to remove problem contractors from the field. Many banks will not issue bonds to bad contractors, so the contractors must, as a result, find other work. In other words, the performance bond is not just about the cash, but about establishing the reputation of the contractor.