Kentucky Performance Bonds
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What Are Kentucky Performance Bonds?
A Kentucky performance bond protects a construction project owner (the bond’s “obligee”) against the financial fallout from a contractor’s default or other contractual violation. The bond serves a preventive purpose by obligating the contractor (known as the “principal”) to meet legal performance standards and contractual specifications. A performance bond also has a compensatory purpose by legally obligating the contractor to pay the project owner’s valid claim for monetary damages resulting from a violation.
Who Needs Them?
Kentucky's “Little Miller Act,” the state’s version of the federal Miller Act, requires contractors to furnish performance bonds (and payment bonds) before they can be awarded state-funded projects valued in excess of $40,000. The performance bond must be in an amount equal to 100% of the contract value.
The Little Miller Act does not apply to privately-funded construction projects. However, it’s not unusual for private project owners to require performance bonds, particularly for high-value projects.
How Do Kentucky Performance Bonds Work?
The third party to a Kentucky performance bond, in addition to the obligee and the principal, is the bond’s guarantor (called the “surety”). To guaranty the payment of claims, the surety agrees to extend credit to the principal for the purpose of paying a valid claim. The surety investigates each claim to make sure it’s valid. If it is, the principal is legally obligated to pay it, but few contractors have the funds to pay a claim in full without delay.
In the construction industry, where time is money, the safest, surest way to make sure the obligee’s claim is resolved quickly is for the surety to pay it on the principal’s behalf and give the principal a certain amount of time to repay the resulting debt. A principal who fails to repay the debt according to the surety’s credit terms is likely to end up losing in court and having to pay court costs and legal fees as well as the debt itself.
How Much Do They Cost?
The annual premium cost for a Kentucky performance bond is calculated by multiplying two numbers: the bond amount and the premium rate. While the obligee establishes the required bond amount, the surety sets the premium rate on a case-by-case basis through underwriting. The primary concern is the risk that the principal won’t repay the credit extended by the surety in paying a claim on the principal’s behalf. The accepted measure of that risk is the principal’s personal credit score.
A high credit score means the risk to the surety is low, so the premium rate will be low. The opposite also applies. A low credit score means a higher risk of non-repayment, which demands a higher premium rate.
A well-qualified principal typically will be assigned a premium rate in the range of .5% to 3%.
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