Payment and performance bonds are obtained by contractors for construction jobs to protect different groups from unmet contractual promises. Public construction projects typically require these bonds, but private projects can also require them. Since the bonds are typically issued together, many don’t understand the difference between the two. Below, we’ll dive into how payment and performance bonds work and how you can get a hold of both so you can work on construction projects.
What is the Difference Between Payment and Performance Bonds?
Performance bonds protect the owner if a contractor doesn’t complete their work as specified in their contract.
Payment bonds protect subcontractors, vendors, and suppliers if a contractor doesn’t pay them what was promised in the contract.
Why Are These Bonds Required?
Performance and payment bonds are required to protect owners, the public, and other parties involved in a surety bond agreement from shoddy work and contract violations. Federal law requires payment and performance bonds for federal projects under The Miller Act.
The U.S. enacted this law since federal projects can’t use traditional liens to protect themselves from incomplete work and other contract breaches. Surety bonds are especially important for federal projects since public funding is used to cover the costs.
Since the federal government passed The Miller Act, states began passing “Little Miller Acts” to have state-specific statutes related to performance and payment bonds.
How Do Performance and Payment Bonds Work?
Performance and payment bonds are three-party agreements between the entity who needs the bond, the surety issuing the bond, and the entity requiring the bond.
For these two particular bonds, contractors are the entities who need the bond. The entity requiring the bond is the owner of the project. This is typically the federal or a state government.
Sureties, like bond agents or surety agencies, issue these bonds after contractors win a construction contract. When a surety issues a surety bond to a contractor, they are guaranteeing that the contractor will fulfill the terms of their contract.
If the contract is not fulfilled and the project owner files a valid claim on your bond, then the surety will pay the claim. Contractors are then obligated to pay the surety for the costs of the claim.
Sureties will typically investigate a claim to make sure it’s valid. If it’s not, then you’re not obligated to pay. If it is valid, then you will need to pay. Bond claims are avoidable as long as you follow what’s promised in the contract.
How Do I Get a Payment and Performance Bond?
You can get a payment and performance bond by applying for bonding with a good bonding agent. These bonds are normally issued together. Below are the general steps you’ll take to get a payment and performance bond.
- Organize your papers: The surety will look at your financials and other documents to consider your application. This can include balance sheets, income statements, personal credit, and tax returns. If it’s possible, consider working with a CPA who specializes in the construction industry to get your papers in order.
- Get the right bond form: Knowing what bond form to use can be confusing since they vary based on your state and the type of bond you need. JW Surety Bonds has most of the common bond forms on file to make this process easier. However, the project owner may have a specific form and language they’d like to use. In this case, you’ll need to get this information to your bond agent when you’re applying for bonding.
- Review and sign the bond agreement: The surety will give you the bond agreement after they’ve reviewed and approved your request. Take a look and get clarity on anything that’s unclear before you sign. After you have a good understanding of the agreement, you’ll sign and return the agreement to the surety.
- Pay the fees: The surety will determine the rate you’ll pay after they review all of your documents. You’re required to pay this rate after the bond is approved.
Payment and performance bonds are crucial for construction projects, but they differ based on who they cover. Understanding how the two bonds work and who’s protected can help you avoid claims in the future. If you’re in the middle of bidding for a job, take a look at the requirements for a payment bond to see what you’ll need to do after if you win.