Key Takeaways
- A completion bond guarantees monetary compensation if a project remains unfinished due to financial issues.
- These bonds protect investors against risks such as a contractor running out of money mid-project.
- Completion bonds are commonly used in industries like film, video games, and construction.
- The bond ensures that projects meet deadlines and stay within budget constraints.
Definition of a Completion Bond
A completion bond is a contract that helps ensure that a project in construction, film, or video games is finished as planned. It’s a financial safety net for investors and stakeholders that helps protect them if a project runs over budget or faces delays. By ensuring funds or support are available to complete the work, completion bonds reduce financial risk and increase confidence in large projects. Keep reading to learn how completion bonds work and why they’re important in project financing.
Understanding How Completion Bonds Work
A completion bond is a particular type of surety bond. A surety bond is a financial guarantee that compensation will be paid to a given party if a contract is not performed to satisfaction or completion. A surety bond is a contract entered into by at least three parties. The first is the obligee, who is the client, owner, or party that requires the bond to be posted for its protection. The second is the principal, who is the primary party that promises to complete the project or contract. The third is the surety or obligor, who assures the obligee that the task or project can be fulfilled to completion.
Completion bonds are often used for complex projects involving large sums of money or multiple investors. To secure the necessary financing, a contractor will make a loan guarantee to a lending institution in the form of a completion bond. The bond guarantees that the project will be completed on time, within budget, and free of liens. A third-party guarantor will assess the risk to the project’s completion and collect a premium for insuring the particular risks of a given project. Thus, a completion bond ensures that a creditor still receives principal and interest even if the project fails to reach completion.
Differences Between Completion Bonds and Performance Bonds
A completion bond provides more coverage than a performance bond. A performance bond is an indemnity bond that guarantees satisfactory completion of contract work by a contractor. Whereas completion bonds create a guarantee between the obligor and its lender as obligee, performance bonds create a guarantee between the obligor and the contractual obligee.
The obligee receives compensation for any losses incurred if the obligor breaches the contractual terms of the agreement. Multiple completion bonds may be required for each contract within a project.
Real-World Examples of Completion Bonds
The reasons why projects are not completed differ between industries. Naturally, completion bonds must also work slightly differently for projects in various businesses.
Completion Bonds in Construction Projects
Since construction projects can take many months or even years to be completed, the risks for investors can be high. Investors are much more likely to get involved if a completion bond is provided. This way they know that they will receive their money back with interest if the project is not completed.
Use of Completion Bonds in the Entertainment Industry
Completion bonds are a long-standing tradition in the entertainment business. Many variables can come into play that may affect the completion of a large film project. In this case, producers of the movie will provide a completion bond to a bank to finance the film project. In return for guaranteeing repayment of the loan, the producers generally do not have to make any loan repayment until the project is completed. All professionals working on the film benefit from the completion bond because producers are discouraged from terminating the project before completion.
Completion Bonds in Mortgage Financing
A completion bond may be part of a mortgage financing deal, and it protects both the mortgagor and mortgagee. A third-party financier, often a completion guarantor company, typically becomes involved in the deal. The third-party provides a financial backstop if the original financing is insufficient to complete the project.