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A performance bond is a surety instrument that guarantees a contractor will complete a project according to the terms of a contract. If the contractor defaults, fails to perform, or abandons the project, the surety company that issued the bond steps in to either complete the project, hire a replacement contractor, or pay the project owner up to the bond's face amount to cover completion costs. Performance bonds are standard requirements on U.S. federal construction projects exceeding $150,000 under the Miller Act, and most state and local government projects follow comparable bonding requirements.
Think of a performance bond as a financial backstop for a construction contract: the surety company guarantees the contractor's performance the same way a cosigner guarantees a loan.
Three parties are involved in every performance bond arrangement. The principal is the contractor who purchases the bond. The obligee is the project owner who requires the bond as a condition of the contract. The surety is the bonding company that issues the guarantee and assumes the risk of non-performance.
When the principal defaults, the obligee makes a claim against the bond. The surety investigates the claim, confirms the default, and selects from several remedies: hiring a replacement contractor to finish the work, financing the original contractor to complete it, paying the obligee the cost of completion up to the bond amount, or waiving its rights and allowing the obligee to complete the project on the surety's account. The surety's obligation is capped at the bond amount, which is typically equal to the full contract value.
| Performance Bond | Payment Bond | |
|---|---|---|
| Protects | The project owner against non-completion | Subcontractors and suppliers against non-payment |
| Claim Trigger | Contractor fails to complete the work | Contractor fails to pay downstream parties |
| Miller Act Requirement | Required on federal contracts over $150,000 | Required on federal contracts over $150,000 |
| Who Files a Claim | Project owner (obligee) | Subcontractors, suppliers, laborers |
Performance bond premiums typically range from 0.5% to 3% of the total contract value, depending on the contractor's financial strength, bonding history, and the complexity of the project. A well-established general contractor with a strong balance sheet and years of bonding history pays closer to 0.5% to 1%. A newer contractor or one with past bond claims pays closer to 2% to 3%. On a $10 million contract, that range means a premium of $50,000 to $300,000.
The surety evaluates the contractor's financial statements, current backlog of work, management experience, and past project performance before issuing a bond. A contractor who is already stretched thin across too many projects may be declined for bonding even if their credit history is clean.
Performance bonds are not limited to government contracts. Private developers on large commercial construction projects frequently require performance bonds from their general contractors, particularly on complex projects where a contractor failure would cause serious schedule and financial damage. Lenders financing construction projects often require performance bonds as a condition of the construction loan, because the bond reduces the lender's risk of being left with an incomplete project as collateral.
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