Contractors know the value of always having the right tool for the job. When it comes to getting the surety bonds needed for bidding on a construction contract, it’s equally important to choose the right bond for the job.
Payment bonds and performance bonds are two types of surety bonds that contractors often need to obtain when working on a contracted job. These two types of surety bonds are typically purchased together, but they perform two different and equally critical functions. In this article, we’ll examine the issue of distinguishing a payment bond vs. performance bond, as well as the surety bond costs that contractors can expect to pay for payment and performance bonds.
Contractor Bond Basics
When a contractor bids on a project, the project owner often requires the contractor to obtain a surety bond to guarantee the contractor’s obligations. This bond is in addition to any contractor license bonds that a contractor may already have for licensure with the state, county, or city. A surety bond is a three-party contract between the contractor, the project owner, and a neutral guarantor that provides a financial guarantee that a contractor will fulfill the terms of the contract they are bidding on. (See What is a Surety Bond? for an in-depth explanation of how surety bonds work.)
Contractor bonds are most often required for contracts where the project owner is a local, state, or federal government agency. This is due to laws such as The Miller Act that require construction contractors to obtain surety bonds before accepting government contracts. However, the owners of private construction projects also often require contract surety bonds to protect their investment and safeguard their financial liability.
When a contractor submits a bid for a government or large private construction contract, they will be required to obtain a bid bond demonstrating that they have the wherewithal to accept and complete the contract. If the project owner awards the contract to that contractor, the contractor will be required to obtain payment bonds and performance bonds.
What Is a Payment Bond?
A payment bond is a type of surety bond guaranteeing that a contractor will pay their subcontractors and suppliers. Most construction projects large enough to require a formal bid process will use multiple subcontractors and require large amounts of building materials. The payment bond protects the project owner from financial liability if the contractor fails to pay their subcontractors or suppliers.
When a subcontractor or supplier is unable to obtain redress from a contractor, they can file a claim with the surety that issued the contractor’s bond. The surety investigates the claim and, if the claim is valid, pays the claimant. The bonded contractor is fully responsible for re-paying the surety.
What Is a Performance Bond?
A performance bond is another type of surety bond guaranteeing that a contractor will complete a project to the satisfaction of the project owner. Performance bonds protect against failure to complete the project, defects in workmanship, code violations by the contractor, or contractor bankruptcy.
The claims process works similarly to the claims process for a payment bond, except that it’s the project owner (government or private) who files the claim. Project owners often use funds recovered through the claim process to pay a new contractor to complete the project.
In some cases, the term “performance bond” refers to bonds required to get a certain licensure or permit from a government agency. These are known as non-contract performance bonds. If you need a performance bond that isn’t related to a contract, contact Surety Bonds Direct to get expert advice on which bond you need.
Maintenance Periods vs. Maintenance Bonds
“Maintenance period” and “maintenance bond” are two other important concepts that are frequently relevant when discussing construction project bonds. Here’s the key difference between the two:
- A maintenance period is a feature of a performance bond that specifies the period of time for which a contractor is financially liable for any defects in a completed project. If the bond has a maintenance period, the contractor will be obligated to perform or pay for any required maintenance within that period.
- A maintenance bond is a separate kind of surety bond that the government or a private property owner requires when awarding a maintenance contract to a contractor. A maintenance bond provides a financial guarantee of the contractor’s obligation to perform the work described in the maintenance contract.
The Surety Bond Process for Payment and Performance Bonds
As part of the bid process, the government agency or private party that owns the project will stipulate which surety bonds are required. In most cases, a contractor will need to obtain both a payment bond and a performance bond. In these cases, the contractor will often purchase payment and performance bonds together in a so-called “P&P bond” package.
The contractor will apply for a surety bond premium quote through a surety or surety bond broker. Several factors determine the surety bond cost for payment bonds and performance bonds. The premium that the contractor pays is a percentage of the total bond coverage amount (also called the penalty sum). Most project owners require that the bond cover 100 percent of the value of the project.
The contractor’s credit report and business history also affect the surety bond cost. A contractor with good credit will typically pay lower rates, as will contractors with a lot of experience, stable finances, and no history of surety bond claims. (However, it’s still possible to get a surety bond with bad credit.)
Assembling a contract bid requires a lot of work and preparation, so contractors can save money and take the hassle out of the surety bond process by working with Surety Bonds Direct. Our online surety bond quotes are fast and free, and our surety bond experts will be glad to answer your questions at 1-800-608-9950.
