Who needs a performance bond?
The bond is used to guarantee that the contractor will perform work at a satisfactory standard, and if this is not done, then they have to compensate the recipient party of the contract for any expenses incurred.
Construction bonds are commonly requested by employers, banks, or private individuals who are considering hiring a construction company. This article discusses whether you need one in your own situation, if so how much should be paid, and whether it can be paid as part of your construction fee.
One may wonder why an employer would want to pay large sums to insure against their contractor defaulting on them (and there aren’t many people who could afford such losses). Indeed many builders do not like demanding performance bonds because it makes them feel like the client is treating them with suspicion, and it may make it difficult to negotiate a competitive lump sum price.
However, most major building contractors do run good businesses and probably only demand bonds in special circumstances; usually when they think they can get away with demanding one (e.g. the proposed work looks very risky).
How do you collect on a performance bond?
The surety, or guarantor company, will attempt to recover on the financial guarantee if the contractor fails to comply with its obligations under the contract. Sometimes this is as simple as calling on the original primary lender for assistance in collecting money allegedly owed by an owner of the property that doesn’t pay its bills. The most common method of payment collection involves legal action against one or more parties responsible for paying monies due under the contract (the “obligee”):
(1) First and foremost, the surety company can file suit against an obligee who refuses to make payments;
(2) Second, it will request payment from any party immediately benefiting from services provided under the bond (the “obligor”); and
(3) Third, it will also request payment through the obligee’s insurer.
This third step is often confusing for those not familiar with performance bonds. However, this process is perfectly legal and common practice in every state throughout the United States. This method of payment collection will work whether the “insured” (the obligee) is an individual, partnership, corporation, or association; but does not apply to municipalities (political subdivisions of states).
Are performance bonds taxable?
Performance bonds are a form of tax on commerce. It is like a toll for using the infrastructure (in this case, the country). The bond amount is generally as high as or higher than one month’s salary; therefore, it is not difficult to see how it can be considered as taxation. However, since performance bonds are normally collected from those who willfully enter into an illegal contract with another party, taxing them would appear unfair.
But given that they have willingly entered into an agreement that includes a large sum of money being put in escrow whenever there is a chance of them violating the terms of their contract, it appears reasonable to levy taxes upon these businesses or individuals even if they do not win the case.
When can you release a performance bond?
The release conditions are negotiated between both parties but they must ensure that anyone who does business with them can have confidence in fulfilling their obligations on time and for free. This condition is known as ‘freedom from encumbrance‘.
You may be able to arrange an early release date, though this is always subject to negotiation. You need to ensure you have enough evidence of your progress before it’ll be accepted so don’t rush it.
You can get an early release of the performance bond if you’ve paid more than half of your debt to the client or supplier, or if half of your payment is in your bank account. You must also pay off any interest due on the outstanding debt. The price you’re paying for this privilege will be high if you’re struggling with cash flow though!
When do you stop making payments to subcontractors?
Subcontractor – Pay them as long as they are capable of doing the work. We generally pay on a weekly basis, even if it’s for 10 or 15 days worth of work. If you don’t have enough money to pay them, then politely advise that their services are no longer needed.
They are probably more than willing to help out because they know your situation…and I’m sure you’re not the first person who has had trouble getting paid by the general contractor.
If they quit working before receiving payment…then they will be paid upon termination which is usually 30-45 days after completion of the job site (or 7-10 days after receipt of all final inspections).
General Contractor – You should not be making payments to subcontractors. General Contractors are required to pay their subs within a certain amount of time (I believe it’s 7 days, but I’m sure someone will correct me if I’m wrong) or face steep penalties. If you aren’t receiving payment from the GC, then don’t make payments to your subs until you do receive payment…if ever.