What are Performance and Payment Bonds?
Performance and payment bonds are two types of surety bonds which are often classified with other types of construction bonds. Though they serve different functions, they often are purchased and posted at the same time to provide security for project developers and the state working in the construction industry.
As with any other surety bond form, performance and payment bonds represent an agreement between three parties. These are the principal (the party which is required to post the bond), the obligee (the government agency which determines that a bond is required) and the surety (a bonding company which guarantees the bond).
In this case, the principal is usually a contractor who has been hired for a construction project. The principal is required by the local or federal government to post payment and performance bonds to guarantee that they will act in accordance with relevant government regulations, and that they will pay any partners appropriately
This process protects the project owner, which may be a private entity or the state, and subcontractors, in the case that the contractor defaults on their obligations. The surety, or bonding company, guarantees that cash is immediately available to be paid in damages in the event that a successful claim is made against the principal. Our what is a surety bond page can provide you with more information on how surety bonds work in general. Equally, feel free to read up on our surety bonds FAQ page.
For federal construction projects over $100,000, it is the law that performance and payment bonds must be obtained. This is regulated by the ‘Miller Act’ which dates back over a century.
The so-called ‘Little Miller Acts’ which have been put in place in each state, specify similar conditions for public projects. Most private construction projects, be they residential or commercial, also have a contractual provision that requires contractors to get bonded.
Questions about Payment And Performance Bond
- What is a Payment Bond?
- What is a Performance Bond?
- What are the Similarities and Differences Between Payment Bonds and Performance Bonds?
- How Do Performance and Payment Bonds Work Together?
- How Do I Get a Payment and Performance Bond?
- How Much Do Performance and Payment Bonds cost?
- Who Pays for the Performance Bond?
- Can I Apply for a Performance Bond or Payment Bond with Bad Credit?
- Other Common Questions About Performance and Payment Bonds
- When are Performance and Payment Bonds issued?
- How Are Claims Made Against Performance Bonds?
- How Are Claims Made Against Payment Bonds?
What is a Payment Bond?
A payment bond is a type of contract surety bond which guarantees that a contractor or subcontractor will pay their subcontractors, material suppliers or laborers for the work and materials provided.
What is a Performance Bond?
A performance bond, on the other hand, is a type of contract surety bond which guarantees that a principal will fulfill their contractual obligations under a project.
What are the Similarities and Differences Between Payment Bonds and Performance Bonds?
Payment bonds and performance bonds have a number of similarities and differences. They are similar in that they are both types of surety bonds, and therefore operate in the same way that other surety bonds do. They are both required in construction projects and are generally used as a form of protection for those working with contractors.
However, payment bonds primarily protect those working for contractors, whilst performance bonds primarily protect those who hire contractors.
How Do Performance and Payment Bonds Work Together?
Performance bonds are meant to protect the owner from the contractor defaulting on their obligations. Payment bonds are meant to guarantee to the subcontractors, suppliers and laborers who the general contractor hires that they will receive payment for services and materials.
A payment bond and a performance bond are usually issued alongside each other, in particular on federal or state projects, but also on private projects. Typically, the surety company underwriting the bid bond on a project also underwrites the payment and performance bonds.
A surety which would otherwise not issue a performance bond to a contractor it deems unsafe won’t issue a bid bond to that contractor either. Reversely, when a surety underwrites all three bonds, this is a sign of its guarantee and its assurance that the contractor is reliable.
How Do I Get a Payment and Performance Bond?
How Much Do Performance and Payment Bonds cost?
Performance and payment bonds costs can vary greatly, depending on a number of case-specific factors.
One of the key factors is the value of the surety bond you are required to post. This value will vary depending on the scale at which, for whom, and in which state you are working. It is common, but not universal, practice for contractors to post bonds worth the full contract price.
Payment and performance bonds do not cost potential bond holders the full value of the bond. Rather, applicants must pay a bond premium, which is a small percentage of the overall bond amount. This premium is sometimes known as the bond cost or bond price.
The rate that applicants must pay for their premium varies depending on the size of the contract, and the applicant’s personal credit score. Small to medium sized performance bonds tend to cost around 3% of the overall bond value. However, for much larger contracts, rates can be as low as 1% of the bond amount.
For construction projects which are above $250,000, surety companies will make a closer examination of the contractor, their financial health, project history, experience, and other active bonded projects in order to determine the price of their bond. Due to the more extensive examination, this process can take longer than normal.
For more accurate information on the cost of your specific bond, you can use our surety bond cost calculator.
Who Pays for the Performance Bond?
The performance bond is paid for by contractors who are obliged to post performance bonds. However, they are only required to pay the bond premium, a small percentage of the overall bond value, unless a successful claim is made against them.
Can I Apply for a Performance Bond or Payment Bond with Bad Credit?
There are no bad credit programs for performance bonds or payment bonds as there are with most other surety bonds. However, contractors with slight but not extreme credit issues are often still able to obtain such bonds under certain circumstances.
If you have questions about getting a bond with less-than-perfect credit, call us at (877)-514-5146 to speak to one of our surety bond experts and find a solution.
Other Common Questions About Performance and Payment Bonds
When are Performance and Payment Bonds issued?
These bonds are usually issued once a contractor has successfully won a contract bid. If a contractor has had to obtain a bid bond, it is usually the case that the same surety will also underwrite their performance and payment bond.
How Are Claims Made Against Performance Bonds?
The claims process against a performance bond requires a number of stages. The first is to verify whether a legitimate contractual default has occurred. Unless the contractor admits that a default has occurred, and that they have failed to meet their bond requirements, the surety will examine the case. If the surety finds that the terms of the bond have been broken, then they are obliged to amend the situation.
If the surety is required to act, they must compensate the obligee, or to find a way to finish the project within the limitations of the performance bond amount. However, this situation can easily be avoided if contractors work closely with their surety and communicate effectively when troubles arise.
How Are Claims Made Against Payment Bonds?
Before a subcontractor, supplier or laborer can file a claim against a payment bond, there are a number of requirements they need to fulfill. Payment bond claims require that subcontractors file a preliminary notice of a claim within a certain time frame after they have completed work on the project. Not following this procedure may result in the claim being rejected.
For federal projects, the Miller Act specifies a timeframe for second-tier contractors which is 90 days after the last piece of work. First-tier claimants on a federal project do not need to file a preliminary notice.
For public projects, this timeframe is usually specified by state regulations along with other requirements for raising a claim against a bond. Private construction projects also have their own requirements, along with those provided by the state, which are usually specified within the contract and the payment bond itself.
If a legitimate claim against the payment bond is made, the surety has to step in and compensate all sides which have not been paid by the contractor. Any money paid by the surety is then paid back to it by the contractor.
Problems with both performance and payment bonds can be avoided by working with an A-rated and T-listed surety bond company. This partnership means that you are guaranteed reliable and secure support to help you face whatever difficulties arise and provide you with expert support. At Lance Surety, we partner with only the best surety companies. By working with us, you will be investing in much more than a surety bond. You will be investing in a lasting and reliable business relationship.
If you still can’t find what you’re looking for, then feel free to reach out to us on 8775145146. We can also always be accessed through our live chat. To stay up to date with the latest news and information from the Surety Industry, be sure to follow our Lance Surety Blog.
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