The Importance of Payment and Performance Bonds

In the construction world of surety bonds, two of the most sought after surety bonds are performance and payment bonds.  Performance and payment bonds are often confused as the same kind of bond. Although they are both required on construction projects, they have different purposes.

Payment bonds are bonds that guarantee that the contractor will pay all laborers, material suppliers, and sub-contractors per contractual obligations.

A performance bond is issued to guarantee satisfactory completion of a project by a contractor. It protects the owner in case the contractor fails to fulfill the contractual obligations. If the obligations are not met, the surety company will step in and pay the claim and then seek reimbursement from the contractor.  Performance bonds are used to protect the owner, contractor and the people associated with the project (i.e. the public). Government or corporate entities often require performance bonds and payment bonds for any task where taxpayers’ investments need to be protected. In government projects, one submits an application for such projects as bridges and roads.

Performance bonds are generally issued for 10% to 20% of the contracted amount but may be fixed by local laws. Performance bonds are usually issued in an amount equal to 50% of the value of the construction contract.

The premium stays the same, regardless if you need a performance bond, payment bond, or both. But, the cost can vary widely, depending on which surety bond producer you choose to work with, there are general guidelines which suggest that the rate is 3% for all bonds that are $250,000 and less. But it is important to factor in, that for companies with a bad credit history, the bond rates may be higher because there is more work and risk involved in issuing the bond.

Performance and payment bonds are not the same as an insurance policy. The main difference being, that an insurance policy, defends and covers the insured.  A surety bond protects the general public or those involved with the project.  A claim on a bond ensures that the surety company evaluates the claim to make sure that it is valid.

Before approving a payment or performance bond, the surety company checks the applicant’s character, history of contract performances, necessary equipment, financial strength, history of paying subcontractors and suppliers on time, bank relationships and an established line of credit.

Summary:

Performance and payment bonds are both needed in the contracting industry when working on certain projects.  A performance bond guarantees that the contractor will adhere to contractual obligations in the surety bond, whereas a payment bond helps to guarantee that a contractor will pay all those associated with the project (subcontractors, plumbers, electricians, etc.) The premium stays the same, regardless if one needs a performance, payment bond or both.  Performance and payment bonds are not the same as an insurance policy.

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