How Performance Bond Benefit Construction Businesses

The construction sector is massive, employing millions of people around the world. 

The sector comprises of construction businesses and development companies primarily engaged in the construction of buildings or engineering projects like highways and utility systems.

In the U.S, the market size of the construction sector was valued at around USD 1.8 trillion in 2022, with spending on private construction continuing to grow. Construction of private residential and non-residential buildings have seen some of the biggest ever-recorded growth.

In Canada, the construction sector employs over 1.2 million people and, together with the U.S., the North American Construction Market that is segmented by country (Canada and United States) was valued at around USD 2.46 trillion in 2024 and is expected to reach USD 3.11 trillion by 2029.

The North American construction market is projected to grow at a rate of about 4.82% during the forecast period between 2024-2029. This means business opportunities in the construction sector are poised to increase.

If you are considering entering into the construction sector, or you are already a business owner in the construction and real estate development industry, you may come into a windfall in the growing sector, especially if you leverage performance bonds.

But what exactly are performance bonds, and how can they benefit your company.

What Is a Performance Bond?

A performance bond, sometimes also known as a contract bond, is a type of surety issued as a guarantee against the failure of a party to meet obligations specified in a contract. 

In the construction sector, a performance bond is simply a type of surety bond that project owners or the contractor's employer require to protect themselves from financial loss if the contractor fails to complete the project. It’s designed to guarantee a project or contract completion.

As you might expect, there are different types of performance bonds, and each one serves a specific purpose and may be applicable or more popular in a specific jurisdiction than another.

So, for example, if your business is based in a province/region in Canada, it helps to consider the most popular types of performance bonds in Canada and how they can benefit your business.

Similarly, if your business is based in the US, UK, or any other country in the world, it is advisable to research and explore the most common or popular types of performance bonds available in the construction market in your country. 

Common Types of Performance Bonds

Generally, there are two standard types of performance bonds around the world: "On Demand" and "Conditional." 

On Demand performance bonds are usually provided by banks whenever a payment is demanded by the project owner or contractor's employer, ie on-demand, irrespective of whether or not the contractor is in default of the underlying construction contract. 

Conditional Bond, on the other hand, is issued by an insurance company if the contractor is in default of the underlying construction contract, provided that certain specified conditions are met. As such, a Conditional Bond may require litigation before any payment is obtained. 

In the Canadian construction market, three of the most popular types of performance bonds (which may or may not fall under those two broad/standard performance bond categories) are:

I. CCDC Performance Bond

A standard surety performance bond form provided by Canadian Construction Documents Committee guaranteeing performance of the contract by the Contractor.

II. SAC Headstart Subcontractor Performance Bond

A performance bond wording preferred by General Contractors when requesting performance bonds from subcontractors.

III. Form 32 Performance Bond

A new standard bond wording utilized in Ontario by all public entities for contracts over $500,000.

Parties Involved in Performance Bond Agreements

Three parties are involved in a performance bond agreement:

• The obligee: the entity who requires the bond, typically a government agency or municipality
• The principal: the business or individual who will be performing the work specified in the contract
• The surety: the company that provides the bond and guarantees the completion of said work

How Performance Bond Work

In a performance bond, an obligee requires the bond as protection against shoddy work or non-completion of a project. 

Performance bonds are typically in the amount of 50% of the contract amount, although they can also be issued for 100% of the contract amount. 

The principal obtains the bond to bid on jobs requiring one. 

And finally, the surety underwrites the bond and agrees to pay the obligee if the principal fails to meet their obligations. 

Benefits of Performance Bonds

There are at least two key benefits of performance bonds:

1. They Protect the Oblige

If the contractor fails to meet their obligations, the performance bond will cover any financial losses incurred by the oblige. It includes things like cost overruns, delays, and subpar work.

Performance bonds also offer some protection for the contractor. If they are accused of not meeting their obligations, they can use the bond to prove that they did everything they were supposed to do.

Some will require a performance bond as part of the contract. Others will allow the contractor to get one on their own. 

But in either case, it's generally a good idea for the contractor to have one. They offer peace of mind and protection against financial losses.

2. They Improve Your Chances of Getting the Job

If you're bidding on a project, having a performance bond can give you an edge over your competition. It shows that you're a responsible contractor willing to stand behind their work.

And if you're a small business, a performance bond can level the playing field against larger companies.

Performance bonds are not required for every job. But if they are, they can be the difference between winning and losing a bid.

Conclusion

As a construction business owner, you are responsible for ensuring that your projects are completed on time, within budget, and to the required standards. Performance bonds provide financial protection if you are unable to do this.