Performance Bond

A performance bond is a type of surety bond that serves as a financial guarantee that a contractor (the principal) will complete a project according to the contract’s terms, conditions, and price. It protects the project owner (the obligee) by covering financial losses or completion costs if the contractor fails to perform.

If the contractor defaults, by abandoning the project, missing deadlines, or failing to meet specifications, the surety company that issued the bond will step in to ensure the project is completed or compensate the project owner, up to the bond’s value. The contractor must then reimburse the surety for any claims paid.

Performance bonds are most often used in construction, but they’re also common in real estate development, government contracts, and long-term service agreements (like janitorial or IT projects).

A performance bond acts as a safety net for a project. It’s a guarantee from a surety company that a contractor will complete the work as promised in the contract — on time, within budget, and to the agreed standards. If they don’t, the bond ensures the project owner is financially protected.

Here’s how it works, step by step:

1. Three parties are involved:
   • The contractor (principal) who is responsible for the work.
   • The project owner (obligee) who requires the bond.
   • The surety company that provides the financial guarantee.
      
2. Before work starts, the surety reviews the contractor’s finances, experience, and track record to make sure they’re capable of finishing the project.
    
3. Once approved, the bond is issued and the contractor starts work under the contract.
    
4. If the contractor fails to deliver — for example, by abandoning the project, missing deadlines, or not meeting quality standards — the project owner can file a claim with the surety.
    
5. The surety investigates the situation. If the claim is valid, it will step in by either:
   • Paying the project owner for financial losses (up to the bond amount),
   • Helping the original contractor complete the work, or
   • Hiring a new contractor to finish the project.
      
6. Afterward, the contractor must repay the surety for any costs the surety covered.
    

In simple terms, a performance bond protects the project owner from financial loss and ensures the work gets done, even if the original contractor can’t finish the job.

The main purpose of a performance bond is to protect the project owner from financial risk and ensure that the project is completed as agreed. Key benefits include:

• Financial Guarantee: Provides a legally binding assurance that the contractor will deliver on all contractual obligations, including scope, quality, schedule, and budget.
• Protection for the Owner: Safeguards the project owner from financial loss if the contractor defaults, underperforms, or abandons the work.
• Ensured Completion: Empowers the surety to step in — either by financing the existing contractor, hiring a replacement, or covering completion costs — ensuring the project reaches the finish line.
• Risk Mitigation: Reduces exposure to costly delays, substandard work, or contractual breaches, strengthening overall project risk management.
• Builds Confidence and Trust: Demonstrates the contractor’s financial stability and reliability, which can be decisive when securing competitive bids or winning high-value contracts.
• Cost Predictability: Because the bond premium is typically built into the total contract price, project owners benefit from added protection without unexpected expenses.
   

A performance bond is more than just a formality, it’s a strategic risk management tool that helps ensure successful project delivery, financial accountability, and long-term trust between all parties involved.

Performance bonds are typically required by any party that has a financial stake in a project’s successful completion. They’re most commonly used by project owners, government agencies, developers, lenders, and investors to protect against losses if a contractor fails to deliver.

Construction and Real Estate Development

The construction industry is the most common user of performance bonds. They ensure contractors deliver projects on time, within budget, and according to contract specifications. Project owners — including public agencies and private developers — typically require them for:

• Public infrastructure and transportation projects
• Commercial and residential developments
• Large-scale renovations and tenant improvements
   

Government Projects

Performance bonds are legally required on most government construction contracts. This ensures taxpayer-funded projects are completed responsibly and without financial risk to the public. Requirements include:

• The Miller Act – mandates performance and payment bonds on federal projects over $100,000
• Little Miller Acts – state and municipal versions of the same requirement
   

Private Sector Projects

While not always required by law, many private stakeholders demand performance bonds to protect their financial interests. These include:

• Developers and investors funding large-scale projects
• Lenders and banks as part of financing conditions
• General contractors requiring subcontractors to provide bonds
• Commercial property owners or tenants undertaking major build-outs
   

Specialized Industries

Performance bonds are also used outside of traditional construction when project delivery or service continuity is critical, such as:

• Janitorial and facility management – guaranteeing long-term service contracts
• IT and technology services – ensuring completion of complex systems or integrations
• Energy and utilities – especially in public-private partnerships or infrastructure projects

The cost of a performance bond, called the bond premium, is usually a small percentage of the total contract amount (known as the penal sum). Most contractors pay about 1% to 3% of the project value.

For example, a $100,000 bond might cost $1,000 to $3,000. Contractors with strong credit and experience often pay less, while higher-risk applicants may pay up to 10%.

What Affects the Cost

Several factors influence how much you’ll pay for a performance bond:

• Credit score: Personal and business credit history plays a major role.
• Financial strength: Working capital, net worth, and cash flow all impact rates.
• Bond amount: Larger bonds involve greater risk and often more scrutiny.
• Project scope: More complex or higher-risk projects may result in higher rates.
• Bonding history: A strong track record with no past claims helps reduce premiums.
   

Performance bond pricing is ultimately a reflection of risk transfer. The more confidence a surety has in a contractor’s financial stability, experience, and ability to complete the project, the lower the premium will be. Because sureties must stand behind their guarantee with their own capital, they conduct underwriting with the same rigor that banks apply when issuing loans.

Additional Costs to Consider

Beyond the premium, some small extra costs may apply, such as:

• Some sureties may charge processing or credit report fees.
• Working with a broker could involve service fees, although many include this in the quoted premium.
• For smaller projects, some sureties offer flat-fee performance bonds (e.g., $250 for bonds under $50,000), making them more accessible for small contractors.

Securing a performance bond involves more than just filling out an application — it’s a financial evaluation process. Sureties assess the risk of backing a contractor, and strong financials and experience go a long way in getting approved.

1. Work with a Surety Bond Broker

Partnering with a specialized bond broker like Lance Surety Bonds can streamline the process. A broker will help you complete the application, gather the right documentation, and match you with a qualified surety company.

2. Complete the Bond Application

You’ll need to provide key details about your business and the project, including:

• Business name, ownership structure, and contact info
• Project scope and contract amount
• Required bond type and amount
   

3. Submit Financial Documents

Sureties evaluate your financial health to determine if you’re bondable. Be prepared to submit:

• CPA-prepared business financial statements
• Personal financial statements
• Work-in-progress reports
• Bank and supplier references
   

4. Undergo Underwriting Review

The surety underwriter will assess your credit score, experience with similar projects, financial capacity, and any past bond history. For larger bonds (typically over $250,000), the review process may be more in-depth.

5. Receive Your Bond Quote

If approved, you’ll receive a quote based on a percentage of the bond amount (called the premium). Well-qualified contractors may pay 1–3% of the bond total.

6. Sign the Indemnity Agreement

Before the bond is issued, you must sign an indemnity agreement holding you personally and professionally liable for any valid claims paid out by the surety.

7. File the Bond with the Obligee

Once everything is complete, the bond will be issued and sent to the project owner or public agency requiring it.

Performance bonds are part of a broader group of contract surety bonds that work together to protect all parties involved in a project. Each serves a different purpose and offers specific protections beyond basic performance guarantees:

• Bid Bond: Ensures a contractor will enter into a contract and provide required performance and payment bonds if awarded the project.
• Payment Bond: Guarantees that subcontractors, suppliers, and vendors are paid for their work and materials.
• Maintenance (Warranty) Bond: Covers the cost of correcting defects or faults discovered after project completion.
• Supply Bond: Guarantees timely delivery of materials or equipment as specified in the contract.
• Subdivision Bond: Ensures that a subdivision development is completed according to approved plans and local regulations.
• Right of Way Bond: Guarantees restoration of public property, such as streets or sidewalks, after construction work.
• Site Improvement Bond: Covers specific site work — like landscaping, paving, or drainage — required as part of the project.
   

How They Work Together

These bonds are often issued as part of a bond line, a series of guarantees that protect against different types of risk throughout a project’s lifecycle. While most common in construction, similar bonds are used in service contracts (e.g., janitorial, landscaping, or food service) to ensure obligations are met. Together, they help ensure compliance, payment, quality, and project completion, protecting owners, contractors, suppliers, and the public.

A performance bond typically lasts for the duration of the project it covers. Its validity is directly tied to the contractor’s ability to complete all work as required under the contract and in some cases, to any warranty or defects liability period that follows completion. The bond is considered fulfilled and released only once the contractor has met all contractual obligations.

Typical Performance Bond Durations by Project Type

What Determines a Bond’s Duration

Several key factors influence how long a performance bond remains active:

• Project Length: The bond usually stays in force until the contracted work is completed.
• Contract Terms: It remains valid until all deliverables are accepted and the project owner confirms completion.
• Warranty or Defects Period: Many contracts include a maintenance or warranty period (commonly 6 to 24 months) after completion, during which the contractor must repair or address defects. The bond may remain active through this period.
• Bond Conditions: The bond document may include a “longstop date” or specific terms that define when it expires.
• Project Delays: If a project extends beyond the original schedule, the bond may need to be renewed or extended to maintain coverage.
   

When a Performance Bond Ends

A performance bond typically expires once all contractual obligations are met. This includes:

• Successful Completion: The project is finished according to the contract.
• Warranty Fulfillment: Any defects or warranty periods have ended.
• Formal Release: The project owner issues written confirmation that the bond is no longer required.
   

If a Project Runs Over Schedule

If delays or scope changes push a project past its expected completion date, the bond does not automatically expire. Instead, one of the following actions is required:

• Renewal or Extension: The contractor arranges with the surety to extend the bond’s term.
• Extension Clause Activation: Some bonds include provisions that automatically extend coverage if the project is delayed.
• Additional Costs: If extensions are needed, the surety may charge extra fees for the added risk and time.

Understanding how performance bonds work in practice can help project owners and contractors prepare for challenges and avoid costly mistakes. Below are sample scenarios that illustrate how performance bonds are triggered and resolved.

Example 1: Contractor Default on a Public Project

A general contractor was awarded a $1.5 million municipal project to build a new public library. Halfway through the build, the contractor ran into financial trouble and stopped work. The city, as the obligee, filed a claim against the contractor’s performance bond.

The surety investigated and confirmed the contractor’s default. It arranged for a new contractor to complete the project, using the remaining contract balance and the bond amount to cover additional costs. The original contractor was then responsible for reimbursing the surety.

Example 2: Delays and Deficient Work

A developer hired a bonded contractor to construct a retail center. Although the contractor completed the job, it was delivered two months late and failed several quality inspections. The obligee filed a claim citing failure to meet performance specifications.

The surety determined that the work did not meet contractual standards. It paid the project owner to cover rework and delay penalties—then pursued reimbursement from the original contractor under the terms of the indemnity agreement.

Example 3: Subcontractor-Focused Bond Use

A large general contractor required all subcontractors on a federal job to obtain individual performance bonds. When one subcontractor failed to meet safety requirements and walked off the job, the GC filed a claim. The surety brought in a replacement subcontractor, ensuring the larger project continued on schedule.

These examples show how performance bonds protect projects, preserve timelines, and ensure financial accountability when contractors fall short.

Can you get a performance bond with bad credit?

Yes, but you may pay a higher premium. Strong financials and experience help offset credit risk.

Do you always need a payment bond too?

 In most public and many private projects, performance and payment bonds are issued together.

Are performance bonds required by law?

Yes, they are required for most federal construction contracts over $100,000 under the Miller Act, and for many state and local projects under “Little Miller Acts.” In the private sector, they’re not legally required but are often mandated by owners, lenders, or investors to reduce financial risk.

What’s the difference between a performance bond and a payment bond?

A performance bond guarantees project completion, while a payment bond ensures subcontractors, suppliers, and vendors are paid. Most public projects  and many private ones require both types of bonds together.

What is the difference between a performance bond and a bid bond?

A bid bond ensures that a contractor will enter into a contract and provide the necessary bonds if awarded the project. A performance bond comes into play after the contract is awarded and guarantees that the contractor will complete the work as promised.

Who Typically Pays for a Performance Bond?

The contractor pays for the bond upfront, but that cost is usually factored into the total project price. In other words, the project owner indirectly covers it as part of the job’s budget.

What happens if the project scope changes?

If the project scope significantly increases, for example, due to added work or cost overruns the bond amount may need to be increased or reissued to reflect the new contract value. The surety may also request updated financial documentation before approving the adjustment.

Can performance bonds be transferred to another contractor?

No. Performance bonds are specific to the contractor, project, and contract. If the contractor is replaced, a new bond must typically be issued by the new contractor’s surety.