Chapter 25 - IT Contract Formation

25.8.15 IT performance bonds

Although performance bonds (a surety bond issued by an insurance company to guarantee satisfactory completion of a project by a supplier) are usually used in construction or transportation contracts, the Code of Virginia (§ 2.2-4339) provides that a public body may require a performance bond for contracts for goods or services if provided in the IFB or RFP. For example, a supplier may cause a performance bond to be issued in favor of the agency for whom the supplier is developing and implementing a major IT solution. If the supplier fails to develop and implement the solution according to the contract's requirements and specifications, most often due to the bankruptcy of the supplier, the agency is guaranteed compensation for any monetary loss up to the amount of the performance bond.

Performance bonds are contracts guaranteeing that specific obligations will be fulfilled by the supplier. The obligation may involve meeting a contractual commitment, paying a debt or performing certain duties. Under the terms of a bond, one party becomes answerable to a third party for the acts or non-performance of a second party. Performance bonds are required in a number of business transactions as a means of reducing or transferring business risk. Agencies may require a performance bond for the purpose of reducing public responsibility for the acts of others, and the courts require bonds to secure the various responsibilities of litigants, including the ability to pay damages.

A typical performance/surety bond identifies each of three parties to the contract and spells out their relationship and obligations. The parties are:

• Principal or the party who has initially agreed to fulfill the obligation which is the subject of the bond. (Also known as the obligor/contractor/supplier.)

• Obligee or the person/organization/agency protected by the bond. This term is used most frequently in surety bonds.

• Guarantor or Surety or the insurance company issuing the bond.

The performance bond binds the Principal to comply with the terms and conditions of a contract. If the Principal is unable to successfully perform the contract, the surety assumes the Principal's responsibilities and ensures that the project is completed.

Performance bonds must be in an amount at least equal to 100% of the accepted bid or proposal and should be filed 10 days prior to issuance of the notice of award unless a written determination is made that it is in the best interests of the agency to grant an extension. A certified check or cash escrow may be accepted in lieu of a performance bond. If approved by the Attorney General, a supplier may furnish a personal bond, property bond, or bank letter of credit in the face amount required for the performance bond.

Approval shall be granted only if the alternative form of security offered affords protection equivalent to a corporate surety bond. If a performance bond requirement is not stated in the solicitation and the agency later determines that a bond is needed prior to contract award, the supplier to whom the award will be made shall provide a performance bond, and the agency will pay the cost of the bond.

In IT contracts, a performance bond may be in addition to the E/O insurance requirement, but never in place of it, as E/O insurance is a professional liability insurance that covers just what the term implies, but not remuneration for a supplier bankruptcy situation.