Protection from Non Performance

A performance bond is a prudent means of protecting the owner from non-performance of the contractor. Should the contractor default on execution of the work, the owner will have the ability to complete the project using another contractor and the owner will be protected from the risk of cost overruns due to the need to bring a new contractor onboard mid-stream. This is, of course, provided the performance bond has been purchased in an appropriate amount. It is typical to require a performance bond in the amount of 100% of the contract price.

The contractor may, in turn, also require performance bonds from its subcontractors. It may also wish to assign other risk items that it has obligated itself to onto its subcontractors, including liquidated damages for schedules and even equipment performance.

The owner/host facility can also protect itself from financial loss by requiring the contractor to pay liquidated damages in the event of failure to meet performance standards or a contracted schedule. In addition to mitigating risk of substandard performance or non-performance, it can protect against project completion delays. The prime contractor may, in turn, also use liquidated damages provisions to protect itself from similar issues with its subcontractors. In some cases, delays can have a significant economic impact on the host facility or the prime contractor. As such, passing some or all of this risk (at least for critical path items) onto contractors and subcontractors in the form of liquidated damages, may be a prudent and reasonable approach.

In contracts in which liquidated damages are used as a method to compensate for a lack of performance (either technically or regarding schedule), the liquidated damages can be backed either by a performance bond, corporate guarantee of the contractor or its parent company, or a letter of credit. Generally, a direct pay letter of credit is the most secure vehicle to use, as it allows the owner immediate access to funds held at a bank in the event the project does not perform and an independent engineer certifies as such. Generally, liquidated damages are in the range of 20 to 40% of a contract amount (though in certain situations it may be greater), depending on the type of technology used and the track-record of the contractor.

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