Performance Bonds ~ An Overview

Bond Penalty: Based on contract total

A surety bond is a third party guarantee that the principal (insured) will comply with specific provisions of the bond. A performance bond is a surety bond that guarantees that the principal will "perform" specific contract requirements. Also known as a contract bond, this obligation secures the completion of a construction project or in the case of a service or supply agreement, faithful performance of the terms of the that agreement. Often required on public projects (and obligatory under the Heard Act, the Miller Act as well as various state "little Miller" acts), the bond provides benefits to all of the parties with interest in the project.

The Project Owner

  • The project owner may reasonably assume that the contractor will complete the project on time, on budget and in compliance with the contract specifications.
  • The project owner can trust that a competent surety underwriter has investigated the character, capacity and operating capital position of the contractor to ensure that he or she is likely to successfully deliver a completed work.
  • The project owner may also receive the benefit of lowered cost 'pass throughs' based on suppliers offering preferred supply pricing to bonded contractors (these are covered under payment bond obligations, often paired with performance bonds).

The Contractor

  • The contractor benefits by achieving access to often lucrative public jobs. Performance bond capacity makes contractors more competitive!
  • Contractors are more likely to be offered better supply agreements.
  • Contractors may also enjoy broader access to sub-contractors that are more willing to perform work where a bond guarantees their payment.
  • Banks and finance institutions are much more likely to offer access to capital on projects that are covered by a performance bond.

The Public

  • In the case of public work, performance and payment bonds guarantee timely delivery without any concern that mechanic's liens may be filed against the project property.
  • The performance bond requirement creates a mechanism of open, competitive bidding through which the least expensive bidder is awarded the contract, ultimately saving the taxpayer money.

"Bottom line", all of the interested parties understand that when a competent surety bond underwriter approves a contractor, that the surety has carefully considered the qualifications of the bond applicant before committing itself to guaranteeing his or her work. Contract surety underwriting significantly mitigates the risk of a contractor failure in an inherently risky industry with high failure numbers.

A performance bond premium (cost) is based on the contract total. Usually the bond penalty (bond amount) is equal to the project total, but not always. The obligation guarantees all of the provisions of the contract and will pay the obligee (project owner) money up to the full penalty. Generally, a performance bond is an irrevocable, strict guarantee however that does not mean that the contractor and surety are necessarily at the mercy of the project owner. The obligee must also comply with its obligations to the contractor. An obligee default can result in a full release of the contractor and his surety from their joint obligation.

Performance Bonds Are a Requirement on Federal Work

The Miller Act (40 U.S.C. §§ 3131-3134) is the federal code which requires contract surety bonds on federal construction project. The mechanism is implemented through the Federal Acquisition Regulations (48 CFR Subpart 28.1). The Code obligates a general contractor on a federal job to file a performance bond AND a payment bond when said project exceeds $150,000 for the construction, alteration or repair of any building or public work belonging to the United States. A corporate surety company issuing these bonds must appear on the U.S. Treasury's circular ("T-List") of sureties acceptable for federal obligations.

A "performance bond" must be executed in an amount that the contracting officer deems "adequate" to protect the federal government. The Acquisition Regulations suggest that 100% of the contract price should be the requirement. Exceptions can be made but only by a specific determination by the federal contracting officer who justifies that a lesser amount is adequate.

A "payment bond" is required to ensure that suppliers of labor and materials will be paid for their products and services. The amount of the payment bond must be equal to the total amount payable under the terms of the contract. As with the performance bond, 100% of the contract price is generally the rule. A deviation must likewise be justified by the federal contracting officer by written determination supported by his or her specific findings of fact that the payment bond amount is impractical. The payment bond penalty may NOT be less than the amount of the performance bond. Payment bonds must be posted when the contract value is in excess of thirty thousand dollars ($30,000). The Miller Act payment bond covers subcontractors and suppliers of material who have direct contracts with the prime contractor. These are called first-tier claimants. The payment bond also covers subcontractors and material suppliers that have contracts with a subcontractor. These claimants are called second-tier claimants.

Performance Bonds Are "Often" Required on State and Local Work

Most states have implemented "little Miller Acts" for state-owned projects. Local municipalities also often require payment and performance bonding for contracts that exceed a specific threshold. Those surety bond requirements are generally defined in local requests for proposals (RFPs).

Interested in learning more about contract surety bonds? We recommend two excellent publications on the topic at PerformanceBond.com. Call us at (800) 373-2804, email Underwriting@SuretyOne.com or click here to chat with an underwriter real-time. Performance bond leader, Surety One, Inc. is an experienced underwriter of contract surety bonds. We provided unmatched support of your bid bond need, based on our knowledge about the industry and our focus on our personal relationship with contractors. We facilitate expeditious review and response to your bid bond request in a polite, clear way.

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