Performance Bond
A surety's guarantee that the contractor will complete the work as contracted.
Quick Answer
A performance bond is a three-party surety agreement in which a surety company guarantees the owner that the contractor will complete the project according to the contract. If the contractor defaults, the surety may finance completion, hire another contractor, or pay damages up to the bond amount. It is commonly required on public work.
The Full Picture
A performance bond involves three parties: the principal (the contractor), the obligee (usually the owner), and the surety (the company that issues the bond). The surety is not an insurer in the traditional sense. It underwrites the contractor's capacity and character, and if it pays out because of a default, it generally expects reimbursement from the contractor through an indemnity agreement.
If a contractor defaults, the surety investigates and typically has several options, such as financing the contractor to finish, arranging a replacement contractor, or paying the owner up to the penal sum of the bond. The bond is most often issued alongside a payment bond, which protects subcontractors and suppliers who are not paid. Together they are often called performance and payment bonds.
Bonds are mandated on many public projects. In the federal system, the Miller Act requires performance and payment bonds on federal construction contracts above a threshold, and many states have similar "little Miller Acts." Private owners may also require them, depending on risk tolerance. Cost is usually a percentage of the contract value, and the rate depends on the contractor's financial strength, experience, and project type.
In preconstruction, bonding shows up as a cost to carry in the estimate and a capacity question for the contractor. A surety limits both the size of individual projects and total backlog a contractor can take on. Subcontractor default insurance and subcontractor bonds are separate tools that general contractors use to manage risk below them in the chain, and requiring them affects subcontractor pricing during bid review.
Real Examples
Common Misconceptions
People assume: A performance bond is insurance for the contractor.
Actually: It protects the owner. The contractor remains liable to reimburse the surety after a claim under the indemnity agreement, so a bond is closer to credit support than insurance.
People assume: A performance bond also guarantees that subcontractors will be paid.
Actually: That is the job of the payment bond, a separate instrument that is usually issued together with it.
Frequently Asked Questions
How much does a performance bond cost?
Premiums are typically a small percentage of the contract value, but the rate varies with the contractor's financial strength, track record, and project. Ask a surety agent for current quotes.
What is the difference between a bid bond, performance bond, and payment bond?
A bid bond guarantees the bidder will enter the contract if awarded. A performance bond guarantees completion of the work. A payment bond guarantees that subcontractors and suppliers will be paid.
Is a performance bond required on public projects?
Frequently. The federal Miller Act requires bonds on federal construction above a threshold, and most states have comparable laws for public work, with thresholds that vary.
What happens if the contractor defaults?
The surety investigates and may complete the work, hire another contractor, or pay damages up to the bond amount. The contractor must typically reimburse the surety.
What is bonding capacity?
The maximum amount of work, per project and in total, that a surety is willing to bond for a contractor based on its financial strength and experience.