How Payment and Performance Bonds Work in Construction and Government Contracts
What a payment and performance bond does
A payment and performance bond is a may provide that a contractor will finish a job and pay workers and suppliers. When you bid on a government contract or a large construction project, the project owner often requires you to post a bond before work starts. The bond promises that if you fail to complete the work or pay your bills, a bonding company will step in and either finish the job or pay out money to cover the loss.
The bond protects the project owner, not you. It is a three-party agreement: you (the contractor), the bonding company (the surety), and the project owner (the obligee). You pay a premium to the bonding company upfront, usually a percentage of the contract value. If you default, the bonding company can demand you repay whatever they paid out, plus interest and legal costs.
Government contracts almost always require both a payment bond and a performance bond. Private projects may require one or both, depending on the contract terms. The two bonds serve different purposes but often come as a package.
Key Takeaways
- A performance bond guarantees you will finish the work on time and to specification; a payment bond guarantees you will pay workers, suppliers, and subcontractors.
- Government contracts typically require both bonds; private projects may require one, both, or neither depending on the contract.
- You pay the bonding company a premium, usually 1 to 3 percent of the contract value, and you are liable if the bond is called.
- The bonding company will investigate your finances, experience, and track record before issuing a bond.
- If you default, the bonding company pays the claim and you must repay them in full, plus costs and interest.
Performance bonds versus payment bonds
A performance bond covers the work itself. It guarantees that you will complete the project according to the contract specifications, on schedule, and in a workmanlike manner. If you abandon the job, do substandard work, or miss the deadline, the project owner can file a claim. The bonding company will then either hire another contractor to finish the work or pay the owner the difference in cost between your contract price and what it actually costs to complete the job.
A payment bond covers your debts to others. It guarantees that you will pay all workers, subcontractors, and material suppliers who worked on the project. If you go unpaid or go out of business, workers and suppliers can file a claim directly against the payment bond. The bonding company then pays them. This protects workers and small suppliers who might otherwise lose money if a contractor fails.
On federal projects, the Miller Act requires both bonds. On state and local government projects, similar laws (called "Little Miller Acts") often require both as well. Private projects set their own terms; some require both, some require only performance, and some require neither.
How to obtain a payment and performance bond
You obtain a bond from a surety company — an insurance company licensed to issue bonds. The surety will review your business finances, credit history, experience with similar projects, and track record on past contracts. They will also look at your management team and the equipment you own or can access.
The surety's underwriter will ask for your business tax returns (usually three years), a personal financial statement, bank statements, and references from past clients and suppliers. If you are bidding on a large or complex project, the surety may also conduct a site visit or interview your project manager. The process typically takes one to four weeks, depending on the surety's workload and how quickly you provide documents.
Once approved, you pay the premium — usually 1 to 3 percent of the contract value, though rates vary by surety, your credit profile, and the project risk. A $500,000 contract might cost $5,000 to $15,000 in bond premiums. The premium is not refundable, even if you never use the bond.
You must obtain the bond before you sign the contract or begin work. Most government contracts require proof of bonding in your bid itself. If you win the bid without a bond in place, you typically have 10 to 30 days to post it before work can start.
What happens if you default on a bond
If you fail to complete the work, miss a deadline, do substandard work, or fail to pay workers and suppliers, the project owner or an unpaid worker can file a claim against your bond. The bonding company will investigate the claim. If they find it valid, they will pay it — up to the full bond amount.
Once the bonding company pays a claim, you become liable for the full amount plus interest, legal fees, and investigation costs. The surety will demand repayment. If you cannot pay, the surety can place a lien on your business assets, garnish your bank accounts, or sue you personally (especially if you signed a personal may provide, which most sureties require).
A default also damages your ability to get bonded in the future. Sureties share information through industry databases. If you default on one bond, other sureties will see it and may refuse to bond you or charge much higher premiums. This can effectively end your ability to bid on government contracts or large private projects that require bonds.
The difference between a bond and insurance
A bond is not insurance. Insurance protects you against loss; a bond protects the project owner against your failure. With insurance, you pay a premium and the insurance company absorbs the loss if something goes wrong. With a bond, you pay a premium and you absorb the loss if something goes wrong — the bonding company just fronts the money and then collects from you.
This distinction matters because it means a bond is a debt, not a safety net. If a claim is paid, you owe that money back. If you cannot pay, the surety will pursue collection aggressively, including personal liability if you signed a may provide.
Bid bonds, payment bonds, and performance bonds
On government contracts, you may encounter three types of bonds: a bid bond, a performance bond, and a payment bond. The bid bond guarantees that if you win the bid, you will sign the contract and post the performance and payment bonds. It is usually a small amount — 5 to 10 percent of your bid price — and is only at risk if you win and then refuse to proceed.
Once you win and sign the contract, the bid bond is released and you post the performance and payment bonds, which are usually 100 percent of the contract value each. Some contracts allow you to post a single "combined" bond that covers both performance and payment, though the amount is still typically 100 percent of the contract price.
When you may not need a bond
Private projects do not require bonds unless the contract specifies one. Small projects, repairs, and service contracts often do not require bonding. If you are a sole proprietor doing work for a homeowner, no bond is needed unless the homeowner asks for one.
Some government agencies waive bonding for small contracts — often those under $25,000 to $100,000, though the threshold varies by agency and state. Check the contract documents or contact the contracting officer to confirm whether bonding is required.
If you cannot obtain a bond, you cannot bid on contracts that require one. Some sureties specialize in high-risk contractors or those with poor credit; they charge higher premiums but may be willing to bond you when mainstream sureties will not. However, if no surety will bond you, that contract is closed to you.
Frequently Asked Questions
Can I get a bond if I have bad credit or no credit history?
Yes, but it will be harder and more expensive. Sureties look at credit but also at your business experience, past performance, and assets. If you have a strong track record on previous projects, a surety may bond you despite poor personal credit. Expect to pay higher premiums and provide more documentation. Some sureties specialize in contractors with credit challenges.
What if the bonding company goes out of business?
Surety companies are regulated and must maintain reserves to cover claims. If a surety fails, the state insurance commissioner oversees the claims process. Your bond remains valid and claims are still paid, though there may be delays. This is rare; most sureties are large, stable insurance companies.
Can I use the same bond for multiple projects?
No. Each bond is specific to one contract. The bond amount is tied to that contract's value, and the project owner is named as the obligee. If you win multiple contracts, you need a separate bond for each one. Some sureties offer a "blanket" or "umbrella" bond that covers multiple small projects under one agreement, but each project still has its own coverage limit.
What if I finish the work but a subcontractor sues me for non-payment?
The payment bond protects the subcontractor, not you. If a subcontractor files a claim against the payment bond, the bonding company will pay them. You then owe the bonding company that amount. The bond does not shield you from your own payment obligations; it just ensures the subcontractor gets paid even if you cannot pay them directly.
Do I need a bond if I am a subcontractor, not the prime contractor?
Usually not. The prime contractor posts the bond, which covers all work on the project, including subcontractors. However, some large projects or government contracts require subcontractors to post their own bonds as well. Check your subcontract terms or ask the prime contractor.