Payment vs. Performance Bonds: A Guide for Contractors and Project Owners
In construction, risk management is everything. Owners want assurance that suppliers, laborers, and subcontractors (if applicable) are paid, minimizing the risk of liens filed against their property. They also want assurance that projects will be completed on time and as promised. That's where payment and performance bonds come in.
These two surety tools often work together but serve very different purposes. Understanding the distinction and having the right surety partners can make the difference between a smooth, successful project and costly disputes.
What is a Payment Bond?
Payment bonds, sometimes referred to as labor and material payment bonds, are a guarantee that ensures all parties contributing to a project are properly compensated. This includes:
- Subcontractors
- Material suppliers
- Laborers
Without a payment bond, these parties risk nonpayment if the bonded contractor becomes insolvent or fails to complete the project. In such cases, the unpaid parties may pursue remedies through a mechanics' lien against the property or through litigation. These actions can significantly delay, or in some cases halt, project progress.
Example: A city hires a bonded contractor to build a new library. The contractor falls behind on payments to an electrical subcontractor. Normally, the subcontractor could file a mechanics' lien against the property, which would cloud the city's title and prevent it from selling, refinancing, or even fully opening the building until the dispute was resolved.
However, because a payment bond is in place, the subcontractor files a claim with the surety instead of placing a lien on the property. The surety compensates the subcontractor, and the city retains clear ownership of the library without delays, legal disputes, or restrictions on its use.
What is a Performance Bond?
Performance bonds are designed to protect project owners by guaranteeing that the contractor will complete the project in accordance with terms of the contract. If the contractor fails, whether due to bankruptcy, mismanagement, or inability to perform, the surety will step in.
That may involve:
- Financing the existing contractor to finish the work,
- Hiring a replacement contractor, or
- Providing financial recompense to the project owner.
Example: A contractor is hired to construct a bridge for a city but abandons the project midway. Because a performance bond is in place, the surety intervenes by tendering a qualified replacement contractor under a new agreement with the city. This ensures the bridge is completed as planned, without the city (and taxpayers) absorbing the financial losses caused by the original contractor's default.
Why They're Important
Payment and performance bonds are vital safeguards, keeping projects on track by addressing defaults if they occur and by ensuring contractors are prequalified before work begins.
- For project owners, they ensure projects are completed responsibly, lowering financial risk and safeguarding investor or taxpayer dollars.
- For contractors, they demonstrate financial stability and reliability, strengthening their reputation and opening the door to more opportunities.
- For subcontractors and suppliers, they provide reassurance that their labor and materials will be compensated, giving them confidence to contribute to projects without added financial risk.
Ultimately, these bonds build trust, minimize disputes, and create a stronger, more reliable foundation for every construction project.
When They're Required
- Public Projects: The Federal Miller Act requires contractors to provide payment and performance bonds for most federally funded construction contracts over $150,000. Many state and municipal governments have similar “Little Miller Acts”.
- Private Projects: While not always mandated, private project owners often require bonds on large or high-value projects as a way to minimize financial risk by reducing exposure to contractor default.
Securing Success
Payment bonds and performance bonds serve different but equally important purposes in construction. Together, they form a vital safety net for modern construction projects. With Merchants Bonding Company as your surety partner, you gain more than a bond—you gain the confidence, expertise, and support of a company committed to helping projects succeed from start to finish.
How Do I Get a Surety Bond?
Surety bonds are issued by Merchants Bonding Company through insurance agents. Contact your local insurance agent or use our Find an Agent tool. They will guide you through the process, informing you of what documents and information are needed by the surety (Merchants Bonding Company) to underwrite your bond.
All information provided is subject to change.