What are Performance and Payment Bonds?
Performance bond definition: A type of contract surety bond which guarantees that a principal will fulfill their contractual obligations under a project.
Payment bond definition: 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.
Performance and payment bonds are usually issued for contractors on construction projects. The former serve as a guarantee that the contractor will perform in accordance with contract conditions and state regulations. In other words, the bond is put in place as a protection for the project owner and the state (under federal or state projects), in case the contractor does not perform as per bonded contract. Payment bonds on the other hand are put in place to guarantee that contractors who have hired subcontractors, suppliers or laborers will reward them for their work in accordance with the agreement made between the two sides. The bond further guarantees that such payments will be made in accordance with state laws and regulations.
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.
As every other bond, performance and payment bonds are agreements made between three parties: the obligee requesting the bond (the state or private project owner), the principal who obtains the bond (the contractor) and the surety bond company which underwrites the bond and backs it financially.
If a contractor defaults on their obligations and fails to complete the project a claims process is initiated. The surety bond company then has to step in and assess the situation. If the contractor is found to be in breach of the contract, he or she must compensate the obligee up to the full amount of the performance or payment bond.
As with every surety bond agreement, principals who default on their obligations and are backed by their surety must then repay the surety for its backing. This is part of the indemnity agreement that is signed between the surety and the principal upon issuance of the bond. It is therefore best for contractors to make sure to not to default on their obligations.
Questions about Performance and Payment Bonds
- When are performance and payment bonds issued?
- How do performance and payment bonds work together?
- How much do performance and payment bonds cost?
- Can I apply for a performance or payment bond with bad credit?
- Claims against performance bonds
- Claims against payment bonds
- How to get your 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 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 contractor hires that they will receive payment for services and materials. This way, payment bonds also protect the owner though indirectly.
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 which underwrites the bid bond on a project, also underwrites the payment and performance bonds.
Bid, performance and payment bonds work together to ensure the safety of obligees. 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 much do performance and payment bonds cost?
Your performance and payments bonds’ cost is determined by a number of case-specific factors.
One of the main factors is the amount of the contract which has been awarded during the bid. This amount could be $150,000 or $300,000 and your surety bond cost will vary accordingly.
What you would need to pay for a $150,000 performance bond is not the full amount of the surety bond, though. To obtain a bond, contractors only pay a premium, which is a fraction of the full bond amount.
When determining the premium rate, a surety bond company first looks at the size of the contract, financial of the applicant and personal credit score. Small to medium sized performance bonds tend to cost around 3% for annual premium. However, for much larger contracts, rates can at times be as low as 1% of the bond amount.
For construction projects which are above $250,000, a surety takes an even deeper look at the contractor, their financial health, project history, experience, and other active bonded projects in order to determine the price of their bond. Applying for such bonds usually takes slightly longer, due to the more extensive check performed by the surety.
Can I apply for a performance 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.
Claims against performance bonds
The claims process against performance bonds is a complex one and goes through a number of stages. For a claim to arise at all there has to be an alleged or real contractor default. Sometimes the owner will claim the default (which then needs to be proved) and sometimes contractors themselves will announce default.
The surety then has to investigate the case. If the contractor denies having defaulted, the surety has to check whether there is a real case against the contractor. Depending on the results of its investigation it may decide not to engage, if it finds that its obligations to take over have not matured.
If, on the other hand, the surety finds the contractor to have defaulted, it is obliged to take the necessary steps to amend the situation. It must compensate the obligee, or find a way to finish the project where the contractor left it, all within the limits of the performance bond’s amount.
One of the ways for contractors to avoid a claim against their bond is to work closely with their surety, and communicate often, especially if a project runs into trouble. Many claims are avoided simply by consulting with the surety and taking measures early.
Another important factor is the quality of the surety itself. Working with an A-rated and T-listed surety bond company means that you will have a reliable and secure partner to help you face whatever difficulties arise and provide you with expert support. At Lance Surety Bond Associates, 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.
Claims against payment bonds
It is always best for contractors to avoid claims against their payment bond. If a contractor has difficulties and knows they will not be able to pay their subcontractors, one way of avoiding a claim in the future is by working closely with their surety. This way most potential claims are avoided.
Before a subcontractor, supplier or laborer can file a claim against a payment bond, there are a number of requirements they need to fulfil. Payment bond claims require that subcontractors file a preliminary notice of a claim within a certain timeframe 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.
But if you work with the right surety, you will have someone who will help you out if you run into difficulties. By obtaining a bond through us, you will not only have access to exclusive rates but also to the most professional and reliable companies in the surety bond industry. Where you get your bond from matters!
How to get your performance and payment bonds
The process of obtaining your bonds is simple. First you need to get your performance bond and/or payment bond quote. To get a quote, simply apply online through our highly secure application tool. Depending on the amount of your bond, you may have to submit additional documentation.
For smaller bond amounts the process is relatively fast, while bigger bonds require slightly more time before they are issued. Make sure to call us at (877)-514-5146 at any time, if you have any questions or concerns. Our surety bond experts know all about performance and payment bonds and will be there to respond to your questions. Apply now!