Performance Bond vs. Payment Bond: What Each One Does
Performance bonds and payment bonds are often required together, often confused with each other, and often misunderstood by the contractors who have to obtain them. They protect different parties and respond to different failures.
Before you price
What a performance bond does
A performance bond guarantees that the contractor will complete the project according to the contract. If the contractor defaults, the surety steps in: it can arrange for a completion contractor, take over the project itself, or pay the owner the cost to complete, up to the bond amount.
The performance bond protects the owner. If you fail to perform, the owner has a financial backstop. The bond amount is typically 100 percent of the contract value.
Performance bond claims are serious. A surety that pays a performance bond claim has paid out your default and will pursue you for reimbursement under the indemnity agreement you signed when you got bonded.
What a payment bond does
A payment bond guarantees that the contractor will pay its subcontractors, suppliers, and workers. If the contractor fails to pay, those parties can make a claim on the payment bond.
On public work, payment bonds substitute for mechanics lien rights, which generally cannot be placed on public property. A sub who has not been paid on a bonded federal project files a claim against the Miller Act payment bond instead of filing a lien.
The payment bond protects subs and suppliers. It does not protect the owner directly, but it keeps unpaid parties from disrupting the project by walking off or filing claims against the owner.
When each is required
The federal Miller Act requires both performance and payment bonds on federal construction contracts over $150,000. Most states have similar requirements for state public work.
Private owners can require bonds at their discretion. Large private developers often require performance bonds. Payment bonds on private work are less common but do occur.
The RFP will specify what bonds are required and at what percentage of the contract amount. Read the bonding requirements early. If your surety cannot support the required bond amount, you need to know before you invest time in the bid.
What happens when a claim is made
Performance bond claim: the owner notifies the surety that the contractor has defaulted. The surety investigates and then chooses a completion method. This process takes time. Projects can stall for months while the surety evaluates its options.
Payment bond claim: an unpaid sub or supplier notifies the surety and files a formal claim within the required timeframe (90 days after last furnishing labor or materials on federal work). The surety investigates and, if the claim is valid, pays.
Both types of claims generate indemnity recovery actions against the contractor. Bonds are not insurance in the usual sense. The surety expects to be made whole by you.