Performance and Payment Bonds

Every bonded job needs two promises: finish the work and pay the people. That’s exactly what performance and payment bonds do, one secures completion, the other secures payment, so projects stay on track and disputes stay off-site.

What is a Performance Bond?

A performance bond guarantees the project will be completed according to the contract’s scope, schedule, and quality standards. If the contractor (principal) defaults, the surety steps in, by financing the existing contractor, tendering a completion contractor, or paying valid losses up to the bond’s penal sum.

What is a Payment Bond?

A payment bond guarantees everyone contributing labor or materials gets paid (subcontractors, suppliers, laborers). It reduces lien exposure and payment disputes and keeps projects moving when cash-flow gets tight.

A performance bond guarantees the contractor will finish the work per the contract, while a payment bond guarantees everyone who contributed labor or materials will be paid.

Below is how they differ in practice:

Examples:

• Performance scenario: The GC walks off the job with 30% remaining. The owner declares default, the surety tenders a completion contractor and funds completion up to the bond’s limit. Afterward, the surety seeks reimbursement (indemnity) from the contractor and any personal indemnitors for all paid losses and costs.
   
• Payment scenario: A concrete supplier delivers materials but isn’t paid. The supplier files a payment bond claim with invoices, delivery tickets, and notices; the surety pays the valid, documented amount. The surety then pursues reimbursement from the contractor under the indemnity agreement.

Payment and performance bonds are designed to protect project owners, subcontractors, and suppliers by ensuring that construction projects are completed as agreed and that all parties are paid. In practice, these bonds act as a financial safety net.

When a problem arises, such as a contractor failing to finish the project, or not paying subcontractors or suppliers, a claim can be filed against the bond. The process generally involves:

1. Filing a Claim – The injured party (e.g., project owner or subcontractor) submits a formal claim to the surety company that issued the bond, often providing documentation of the failure or unpaid work.
    
2. Surety Investigation – The surety reviews the claim to verify its validity. This can include reviewing contracts, payment records, and project progress reports.
    
3. Resolution – If the claim is valid, the surety may cover the unpaid costs, arrange for completion of the work, or compensate the claimant up to the bond amount. The contractor is then obligated to reimburse the surety for these payments.
    

Example in practice:
A city hires a contractor for a public infrastructure project. The contractor fails to complete the work on schedule and leaves unpaid subcontractors. The city files a performance bond claim to ensure the project’s completion, and the subcontractors file a payment bond claim for the work they completed. The surety investigates and then either hires another contractor to finish the job or pays the claims directly.

This claims process shows how bonds function as both a risk management tool and a safeguard in real-world construction projects, giving all stakeholders assurance that obligations will be met even if problems arise.

• Federal public projects: The Miller Act generally requires performance and payment bonds above statutory thresholds.
   
• State & local projects: All states have Little Miller Acts with similar requirements (thresholds and procedures vary).
   
• Private projects: Bonding is governed by the contract; often required by owners or lenders on larger or higher-risk work.
   
• Claims & deadlines: Bond forms and statutes impose strict notice and filing windows, missed deadlines can bar recovery.

Most qualified contractors pay a premium equal to 1% – 3% of the contract (bond) amount for combined Performance & Payment (P&P) bonds. This premium is a fraction of the total bond amount, not the full contract value.

How Bond Pricing Is Determined

Pricing is not arbitrary, it reflects a careful underwriting process designed to measure risk. Experienced sureties consider three core steps:

1. Underwriting
   Sureties assess a contractor’s qualifications and the project’s risk profile, including:
   • Creditworthiness — personal and business credit scores.
      
   • Financial strength — working capital, net worth, cash flow stability.
      
   • Experience — proven track record on similar projects.
      
   • Current workload — volume of work in progress and backlog.
      
   • Project risk profile — complexity, duration, and scope.
      
2. Rate Setting
   These factors are used to determine the bond rate, a percentage that reflects the risk level and the contractor’s capacity to fulfill the contract.
    
3. Premium Calculation
   The premium for a bond is calculated by multiplying the contract amount by the bond rate. For instance, a $1,000,000 project with a 2% rate for a combined performance and payment bond would result in a premium of $20,000.
    

Combined vs. Split Bond Pricing

• Combined Pricing (Standard) — One premium covers both performance and payment obligations.
   
• Split Pricing (Situational) — Separate rates may apply if one type of risk outweighs the other.

When split pricing is common:

• Performance bonds: Higher rates when projects involve tight schedules, liquidated damages, design-build responsibility, long-lead items, or heavy self-perform work.
   
• Payment bonds: Higher rates for material-intensive scopes, deep subcontractor tiers, long payment cycles or retainage, or a history of slow payments.
   

Key Cost Drivers You Should Know

Several key factors influence the cost of bonds:

• Contract size: Larger projects cost more in absolute dollars but often benefit from tiered rates that lower the percentage charged.
   
• Contractor qualifications: A strong financial profile, clean bonding history, and proven track record reduce risk and premiums.
   
• Project specifics: Duration, complexity, delivery method, liquidated damages, payment terms, and obligee bond form language all matter.
   
• Claims history: Contractors with a spotless claims record enjoy better rates and higher bonding capacity.
   
• Market conditions: In a “hard” bonding market (tight credit, contractor defaults), rates rise and underwriting becomes stricter.

Performance and payment bonds are widely used across industries to protect owners, contractors, and subcontractors by ensuring project completion and payment. Key examples include:

• Public Works & Infrastructure — Roads, bridges, transit, water/wastewater systems, schools, and public buildings, where bonds protect taxpayer investments and ensure delivery.
   
• Vertical Construction — Commercial buildings, healthcare facilities, higher education, and hospitality projects, often requiring bonds due to complexity and high value.
   
• Industrial & Energy — Plants, utilities, renewable projects, and heavy civil work, where technical complexity and large budgets make bonding critical.
   
• Developer Improvements — Subdivision or plat improvements, frequently secured with separate improvement or site bonds to ensure completion.
   
• Service & Specialty Trades — Electrical, mechanical, roofing, concrete, and interior work, where bonds are often required by owners or general contractors to guarantee performance and payment.

To obtain P&P bonds, assemble your financials and project details, apply through a licensed surety agency, complete underwriting, then sign, pay the premium, and file the bonds with the project owner (obligee). Underwriting evaluates your character, financial strength, and work history.

1. Prepare Your Documents and Information

• Business & Personal Financials: Recent CPA statements (balance sheet, income statement, cash flow), interims, AR/AP agings, personal financial statement, and recent tax returns.
   
• Project Details: Contract amount, scope, schedule, delivery method, liquidated damages, major subs/suppliers, and payment terms.
   
• Company Profile: Completed contractor questionnaire, WIP/backlog schedule, resumes/references, insurance certificates (GL/WC), bank line of credit letter.
   
• Bond Forms: Obtain the owner’s performance and payment bond forms (or confirm use of standard industry forms).
   

2. Apply Through a Licensed Surety Agency

• Choose a provider: Work with an agency such as Lance Surety Bonds that partners with multiple A-rated/T-listed sureties.
   
• Submit your file: Application + financials + project package. Your agent will size requested single and aggregate limits and flag any form issues.
   

3. Underwriting and Approval

• Underwriting Process: A surety underwriter will review your application to assess your financial health, work history, character, and overall risk. 
• Receive Bond Agreement: If approved, the surety will present you with a bond agreement outlining the terms and conditions. 

4. Sign the Agreement and Pay the Premium

• Indemnity: Sign the General Indemnity Agreement (GIA) (contractor and, often, owners/affiliates).
   
• Premium: Pay the premium (typically 1% - 3% combined P&P for qualified files).
   
• Issue bonds: Your agency issues executed Performance and Payment bonds with Power of Attorney per obligee instructions.
   

5. Submit the Bond to the Obligee

• File with the owner: Deliver the finalized bonds (and any required riders) by the contract deadline.
   
• Keep copies: Retain originals/copies for project records and closeout.

Are performance and payment bonds typically priced together or separately?

They are most often priced as a combined P&P premium. Split pricing may be used when exposure is disproportionately on one side (e.g., material-intensive jobs for payment risk; high LDs/design exposure for performance risk).

Will change orders affect my bond and premium?

Yes. Increases to the contract amount typically raise the bond amount and premium pro rata. Ask your agent for the bond’s rate tiers to avoid surprises.

How fast can bonds be issued?

Small, clean files can be turned around quickly. Larger programs/first-time placements take longer, especially if CPA statements or WIP need updating.

What criteria determine eligibility for performance and payment bonds?

Eligibility is based on financial strength (working capital, net worth, cash flow, quality and recency of CPA financials), credit history (business and personal), demonstrated performance on comparable projects, current WIP/backlog, banking support (LOC), and alignment between the project’s risk profile and the contractor’s capabilities.

How long does a performance and payment bond remain in effect?

Bonds typically remain in effect for the duration of the contract plus any warranty or maintenance period. Payment bonds may also remain in effect to cover potential lien claims after project completion.

Can a bond be transferred to a new contractor?

Performance and payment bonds are not automatically transferable because they are issued to a specific obligee (owner) and contractor for a specific project and contract. However, under certain circumstances — such as a contract assignment, novation, or approved subcontracting arrangement — the surety may agree to issue a new bond or amend the existing one to cover the new contractor. This always requires surety approval because the surety needs to underwrite the new contractor’s qualifications and risk profile.

Do bond premiums differ by state or project type?

Yes. Rates depend on state requirements, project size, risk factors, contractor qualifications, and local bonding market conditions.