Why You Need Performance and Payment Bonds

Performance and Payment bonds are required by law by private contractors bidding for public construction projects. You can leverage this additional cost by letting a surety firm handle the negotiations between principals and underwriters.

Public authorities which auction bids for construction projects almost always rely on private sector firms. Tenders are usually awarded to the lowest bidder through a competitive sealed bidding process. But the completion of the project requires a guarantee that public money will not be squandered. Surety bonds play a crucial role in ensuring this part.

All bidders are required to to obtain a bid bond to eliminate the possibility of duplicitous or fictitious contractors. The bid bond virtually ensures that the bidder will enter into the contract and complete the project as required. Two more kinds of surety bonds are typically required for a successful construction process.

A performance bond is a written guarantee from a third party underwriter submitted to the principal (usually a public agency) by a project contractor on winning the bid. The guarantee is that the work will be completed as specified within the allotted time and costs agreed upon.

In the event of the failure of such completion, the provider of the surety bond will undertake to make a payment that is pre determined to the principal. Performance bonds usually cover the total amount of the contract price and replace the bid bond after the contract is won. Unlike other insurance policies, the money to be paid by the underwriter is recovered from the contractor.

In the above manner, the performance bond ensures that construction will take place according to the specified terms and conditions.

A payment bond is meant to ensure that laborers, suppliers of material and other subcontractors receive their payments on time through a corresponding undertaking by a guarantor. Certain workers such as mechanics do not have a lien against the completed construction and hence the payment bond is the only protection they have against default by the employer.

Hence the difference between performance and payment bonds is that while the former is a security against non completion but the latter secures the principal against wage or payment claims by employees of the contractor.

It was back in 1894 that Congress passed the Heard Act that authorize sureties such as performance and payment bonds to eliminate risks in federal construction contracts. This was replaced by the Miller Act in 1935. It is now a legal requirement.

Surety bonds are meant to protect the taxpayer’s money from being wasted but some contractors have claimed that they impose a high cost on the contract. It is still possible to negotiate successfully while enabling profit by letting a well networked firm handle this part of your business.

Reference: Surety Bond Professionals