What Are Construction Payment and Performance Bonds?
Payment and Performance Bonds: What are they? Who needs them? And how do they work?
What are they?
Payment bonds guarantee payment of subcontractors, laborers, and suppliers, while Performance bonds guarantee completion of the contract in accordance with all specifications, terms, and conditions. A payment and performance bond combines both forms of protection in a single bond—though payment bonds and performance bonds can also be purchased separately. These bonds offer financial protection for project owners, assuring project owners that their completed projects will be free of all liens.
Who needs them?
Federal projects. Texas contractors selected for federally funded public works projects valued in excess of $100,000 are required to purchase payment and performance bonds.
State-funded projects. The Texas Little Miller Act also requires a payment bond for state-funded projects valued over $25,000. A performance bond is required for projects valued over $100,000.
Private projects. Owners of private construction projects of any size can require payment and performance bonds.
How do they work?
Any failure to live up to the terms and conditions of the bond can result in a claim against the bond. For example, failure to pay a subcontractor on time and in the proper amount gives the subcontractor the right to file a claim against the contractor’s payment bond. As another example, if the contractor defaults on the contract, the project owner can file a claim against the performance bond and collect the funds needed to get the work completed. When the surety company that issued the bond receives a claim, it conducts an investigation to make sure that the claim is valid. The surety company will then pay the claim—but only as an advance on behalf of the contractor, the principal in the surety bond agreement. The financial responsibility for claims ultimately belongs to the contractor, who must reimburse the surety for claims paid.