Bond. Performance Bond

A performance bond is a third-party agreement involving the contractor, the co-op or condo, and the bonding company that guarantees the completion of a construction project in accordance with the contract documents. If the contractor becomes financially distressed or insolvent and is unable or unwilling to complete the project, a bonding company can step in and have the project completed as specified. Thus, if your contractor is bonded and defaults during the course of the project, the bonding company will select a contractor to fulfill the contract and finish the work at the contracted price.

One clear advantage of a performance bond is that if you engaged your original contractor at a low price, the bond guarantees that this price will be honored to complete the project (excluding any change orders). An added benefit is that contractors must be qualified by a bonding company before they can be issued a bond, assuring you that your contractor has been deemed financially stable and in good standing.

The only reason performance bonds are not standard on all projects is that the cost is passed on to the co-op or condo. As a cost-saving measure, they are commonly omitted. The fee charged to the co-op or condo is typically about 3% to 5% of the total contract cost, meaning a $500,000 project would have an added cost of $15,000 to $25,000.

If a project is not bonded, establishing a healthy retainage is the most effective way to provide at least some measure of financial protection for your co-op or condo against loss when faced with a defaulting contractor. Retainage is the practice of withholding a portion of the value of completed work from the contractor’s payments until work is complete. It is a nearly universal component of construction contracts and not only provides protection to the owner, but also gives the contractor a financial incentive to finish a project as quickly as possible.

Retainage can act as a reserve of money that a co-op or condo can draw upon if the contractor defaults. The amount can vary, but most commonly it’s set at 10 percent of the contract price, proportionately deducted from each progressive payment. While this does not provide the level of protection offered by a performance bond, it can still grant the owner some financial relief if a contractor defaults.

For a project with a budget of less than $500,000 and no down payment required, bonding is probably not necessary. You could still ask your contractor to provide a quote for bonding the project to ensure that a bonding company finds them bondable. Then, based on the quote submitted, you can determine how to proceed with the bond. If you decide against having your contractor obtain one, make sure you stay well ahead on payments by carefully checking that claimed work is properly performed, and maintain a proper reserve of retainage throughout the course of the project.

The co-authors are principals in RAND Engineering & Architecture.