A Bond is a fixed financial instrument that is used as a form of guarantee or promise. The bond is simply a loan made by an investor to the borrower like a company or government. In return, the principal of the loan has to pay the loan with fixed interest to the debtholders by the end of the fixed date. Debtholders are the owners of bonds. Also, a bond gives the profit if it resells at a higher price. When governments, municipalities, states, and companies need capital, they issue bonds. Bonds come in a variety of categories with the most common being cash performance bonds. They are required for public and private contracts as a means of guarantee. In this article, you will get to know the detailed information related to Cash Performance Bonds. Let's begin!
Understanding Cash Performance Bonds
A performance bond is issued to one party as a guarantee that the other party will complete a project according to the terms and conditions of the contract, also known as obligations. If obligations are not fulfilled, the surety company will pay the claim. It provides financial protection to the project owner in case of any failure or default. The project owner can be a state, company, government, or private developer. This is a type of contract bond issued by a bank or an insurance company that acts as a "surety" to guarantee the satisfactory completion of a project.
Furthermore, cash performance bonds are common in the construction industry and real estate development. Cash bonds and performance bonds work hand in hand. Cash bonds are guarantee that the contractor will pay all entities such as material suppliers, subcontractors, and laborers per contractual obligations upon completion of the project. On the other hand, the performance bond guarantees the completion of the project. Both these bonds are linked together to provide the quality finish of the project to the client.
Components of Cash Performance Bonds
There are three separate parties or entities involved in cash performance bond, including:
- The Principal is the main party that is working on the project or who will do the project. This could be a contractor.
- The Obligee is the customer or client, for which the principal is doing work. It can be a state, company, government, or any individual who will be the recipient of work.
- The Surety is the Financial Institution or company, guaranteeing the obligee that the principal will quality finish the work. It is the one providing the cash performance bond.
How does Cash Performance Bond Work?
Performance bonds are performance guarantees, also known as contract bonds. Cash Performance bonds are required for government-related projects, private sector projects and are also common in public jobs. With performance bonds, the bid bond, and payment bonds are also required. The cash performance bond ensures the completion of the project and guarantees that everyone on the project will be paid. Moreover, Cash Performance bonds are also used in commodity contracts.
It is a written guarantee to the beneficiary. Moreover, if the principal fails to meet the criteria of the project outlined in the contract, the obligee can claim against the contractor to recover the financial loss. Then, the surety will compensate the loss of client. The claim must be valid for it. In some cases, surety hires the new contractor for the obligee instead of providing a cash settlement. The surety will take the necessary information from the contractor before issuing the cash performance bond. So in short, it
is an agreement between principal, obligee, and surety.
Cost of Cash Performance Bond
Every bond guarantees a specific amount. The cost of a cash performance bond fluctuates and is affected due to several factors. The first and foremost factor on which bond cost depends is the credibility and financial strength of your company. Also, it depends on the project type and past projects completion by the principal. Normally, the cost tends to be 1% to 1.5% of the contract. It can go up to 3% in the case of larger contracts. The terms of every bond issuing company (surety) are different. They vary from company to company depending on their financial capacity and the company's credit history.
The Bottom Line
In the nutshell, cash performance bonds protect the party by overcoming financial difficulties and damages caused by the insolvency of the principal (contractor). They are a great way to build financial security for all customers. If you're beginning the construction or real estate project, it is wise to secure a cash performance bond that will help you to compensate the money in case of any default by the contractor. But keep one important thing in mind that the cash performance bond is not insurance. If the project is completed by the contractor, it will not cost anything to the obligee. This contract bond protects their investments.