Performance and payment bonds are two types of construction surety bonds often required in a bundle for construction projects.
Performance bond is a type of contract surety bond often used in construction projects to guarantee the project completion according to the terms and conditions, price, and time frame defined in the initial contract. Construction projects involve a lot of risks. Minor project delays or tiny building defects tend to cost millions of dollars for real estate developers, project owners, general contractors, or the local government. Therefore, these entities set up performance bonds to protect themselves from potential risks from the bonded parties.
Payment bond is a type of contract surety bond that guarantees that the subcontractors, laborers and material suppliers will get paid according to the terms and conditions, price, and time frame defined in the initial contract. Construction projects involve a lot of parties, including many subcontractors and material suppliers. In the past, many of them supplied their labor and materials end up not getting paid by the general contractor. Payment bond reduces the risk of non-payment.
Typically, the performance bond and the payment bond are bundled together for purchase.
The price of the bond ranges from 2% to 3% of the project amount. If your project amount is $400,000, your bond would cost anywhere between $8,000 and $12,000. The exact cost of the bond depends on the following factor of the company to be bonded
Bond Amount / Penal Sum: Bond amount is an important part of bond price because bond price is simply a percentage of the bond amount. The higher the bond amount, the higher the bond price would be. Bond amount is typically the cost of the project defined in the contract.
Project Type: Some types of projects are riskier than others. Generally, a performance bond on a subdivision required by government agencies (i.e., state department of transportation, city government) is riskier than a performance bond on a hotel development required by a private real estate developer or a general contractor
Credit Score and Credit History: Applicant company owners’ credit score and history: credit history and credit score is one of the most important factors for bond price. It is an indication of creditworthiness of the bond principal.
Year of Experience & Bond History: The applicant company’s years of experience and prior bond history is also an important determinant of the bond cost. Longer years of experience without any bond claim establishes more trust to the surety / bonding companies that the applicant will be able to finish the project without any bond claim.
Financial Statement & Cash Reserves: For bond amounts greater than $500,000, most bonding / surety companies will require the submission of the applicant company’s corporate financial statements and company owners' personal bank statements. They want to understand whether the company and the company owners have enough cash to cover the bond claim if a claim were to be made.
The bond amount is typically equal to the size of the project. If your project is $100,000, then you may need a performance & payment bond of $100,000.
Payment and Performance bonds are a higher risk category of surety bonds that we cannot instantly issue at this time. Therefore, expect to have your bond in a day if you provide us the required information. When you fill out our 3 minute form, we'll give you a call within 30 minutes (during work hours 9-7pm CST). After we have gathered the information, we will then work on getting you a quote. We may require additional information from you after the initial information gathering.
Three step process:
A real estate developer recently bought land it intended to develop into a hotel. It found a general contractor to perform the development. To be safe, the real estate developer asked the general contractor to obtain a performance & payment bond. The general contractor then bought the bond from an insurance company. Both parties finalized the contract and started the project. Half way through the project, the general contractor realized that they did not have enough staff to complete the project on time, so they lowered the standard of their workmanship without getting consent from the real estate developer. After the project was completed, the real estate developers examined the hotel and realized that it was built with substandard workmanship. The real estate developers decided to file a claim against the performance & payment bond. The surety company then assembled a legal team to investigate the claim. The claim was ultimately found to be valid, so the surety company paid the claims up to the bond amount. However, the surety went after the general contractor to recoup its loss from the claim.
You'll always need performance & payment bonds if you are working on public projects. This is because all public construction projects over $100,000 require their contractors to be properly bonded as per the Miller Act. For many private projects, the project owners still may require a performance & payment bond for their peace of mind.
The three most common types of contract bonds are bid bonds, performance bonds and payment bonds. Here is a brief explanation of what they each is.
Bid Bonds: These are used during the bidding process for construction projects to assure clients that the winning contractor will accept and fulfill the project's requirements. They protect clients from contractors who might submit low bids and then back out if they can't meet the obligations. Bid bonds demonstrate the contractor's commitment and financial capacity for the project.
Performance Bonds: they guarantee that contractors will deliver quality work on time and meet the terms of the contract. They protect clients from contractors who fail to fulfill their obligations. Performance bonds are especially crucial for larger, complex projects requiring substantial investment and expertise.
Payment Bonds: These bonds ensure that contractors pay their subcontractors, suppliers, and others involved in the project. They protect these parties from the risk of non-payment or late payment by the contractors.