You have won the bid. The contract is signed. But before you can break ground, the project owner requires one critical document: a performance bond. Without it, you cannot start work on most public projects—and many private ones as well. This guide explains exactly what performance bonds are, how they work, who needs them, and how to get one.
The Simple Definition
A performance bond is a type of surety bond that guarantees a contractor will complete a construction project according to the agreed-upon contract terms . If the contractor defaults, fails to perform, or abandons the project, the bond provides financial protection to the project owner up to the bond’s penal sum .
The bond is a three-party agreement between :
- Principal: The contractor who needs the bond and must perform the work
- Obligee: The project owner or government agency requiring the bond
- Surety: The company that issues the bond and guarantees the contractor’s performance
If a claim is filed against the bond and the surety determines it is valid, the surety pays the obligee up to the bond amount. The contractor must then reimburse the surety in full .
What a Performance Bond Guarantees
A performance bond guarantees that the contractor will:
- Complete the project according to contract terms and specifications
- Complete the work on time and within budget
- Comply with all contractual obligations
- Perform work that meets quality standards
- Remedy defective work discovered during the warranty period
If the contractor defaults, the surety has several options:
- Remedy the default directly
- Perform the contract themselves
- Solicit bids to obtain a completion contractor
- Pay damages up to the bond’s penal sum
Who Needs a Performance Bond?
Federal Requirement: The Federal Miller Act mandates contract surety bonds for all public construction projects exceeding $150,000 . Some state and municipal laws also require performance bonds on smaller public construction projects under “Little Miller Acts” .
Many private project owners also require contractors to provide surety bonds, even when not required by law .
How Much Does a Performance Bond Cost?
The premium for a performance bond is typically a percentage of the total contract value. For qualified contractors, rates generally range from 1% to 5% of the bond amount .
| Contract Value | Typical Premium (1-5%) |
|---|---|
| $100,000 | $1,000 – $5,000 |
| $500,000 | $5,000 – $25,000 |
| $1,000,000 | $10,000 – $50,000 |
Factors affecting your bond cost include :
- Personal and business credit history
- Financial strength and working capital
- Years in business and industry experience
- Past project performance and claims history
- Size and complexity of the contract
Performance Bond Amount (Penal Sum)
The bond amount, also called the penal sum, is typically set at 100% of the contract value . Some jurisdictions require 100% bonds up to a certain threshold, after which a reasonable percentage may be accepted .
For example, Florida requires 100% bonds up to a contract value of $250 million, and then whatever reasonable amount can be obtained to best secure project completion .
For subcontracts, performance bonds are often valued at between 2.5% and 10% of the contract value . However, the bond amount is always specified in the contract documents.
How a Performance Bond Works
Here is a step-by-step example of how a performance bond functions in practice :
Step 1: The Contract
A general contractor is hired to build a $1 million warehouse. The contract requires a performance bond.
Step 2: The Bond Purchase
The contractor purchases a $1 million performance bond from a surety company, paying an annual premium (e.g., $15,000 for a qualified applicant).
Step 3: The Default
Midway through construction, the contractor goes out of business and abandons the site.
Step 4: The Claim
The project owner files a claim against the bond, seeking funds to complete the project.
Step 5: The Payment
The surety investigates. If the claim is valid, the surety pays the owner up to the bond amount—enough to hire another contractor to finish the work.
Step 6: The Reimbursement
The defaulting contractor (or its bankruptcy estate) must reimburse the surety for the full amount paid, plus legal fees and costs.
Performance Bond vs. Payment Bond
Performance bonds are often issued in conjunction with payment bonds, but they serve different purposes .
Payment bonds are required on public construction projects because mechanic’s liens cannot be filed on publicly owned property. The payment bond becomes the payment remedy source for downstream subcontractors and material suppliers .
Conditional vs. On-Demand Performance Bonds
Performance bonds can be either conditional or on-demand .
Conditional Bonds: The beneficiary must prove that the principal has failed to meet their contractual obligations and has incurred financial losses as a direct result. These bonds are usually issued by insurance companies and carry a single charge independent of the time the bond is in force .
On-Demand Bonds: The beneficiary simply has to submit the bond and demand payment from the surety. The surety is not obliged to provide evidence that the principal breached its obligations. These bonds are normally issued by recognized banks and will be paid without question once demand is made .
The sole defence available to a bond issuer against an on-demand demand is clear fraud of which the bond issuer has notice at the time of the demand . The bond issuer would be required to plead and prove that the beneficiary was dishonest or otherwise had no good-faith belief that the amount was due .
Performance Bond vs. Bid Bond
Both are types of construction surety bonds and often go hand-in-hand :
- Bid Bond: Necessary to ensure all proposals are valid during the bidding process
- Performance Bond: Filed after winning a bid to ensure project completion
How Long Does a Performance Bond Last?
The performance bond remains in effect until the contractor has substantially completed the project according to contract terms . Once the certificate of substantial completion has been issued, the performance bond is returned to the contractor .
However, performance bonds can be drafted to secure performance beyond completion of the contract, including warranty and any operations and maintenance terms . This flexibility is critical for infrastructure contracts performed with O&M terms.
Do Performance Bonds Cover Latent Defects?
Yes, in most states. While state law varies, the majority view among states is that performance bonds cover latent defects for a certain period of years beyond completion of the contract, if such a remedy is not specifically excluded from the terms of the contract .
- Florida: 5-year contract statute of limitations commencing on project completion
- California: 4-year period of limitation, commencing on notice of the defect, with a period of repose of 10 years
How to Get a Performance Bond
The process follows four simple steps, and specialists like Swiftbonds have placed these bonds for contractors nationwide, working with A.M. Best A-rated sureties. Here is how it works:
- Apply: Complete a surety bond application with your company financials, credit information, and the specific contract details (contract value, project type, duration).
- Quote: Within hours, the surety returns a premium quote based on your credit profile, financial strength, and the bond amount required.
- Pay: You pay the premium via credit card, ACH, or wire transfer.
- File: The surety issues the bond, and you file it with the project owner as required by the contract.
Swiftbonds LLC
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Frequently Asked Questions
Q: Is a performance bond the same as insurance?
No. Insurance protects the policyholder. A performance bond protects the project owner. If a claim is paid, the contractor must reimburse the surety .
Q: Who pays for a performance bond?
The contractor pays the premium. The cost is typically built into the contractor’s bid and indirectly paid by the project owner as part of the total contract price.
Q: What happens if a claim is filed against my bond?
The surety investigates. If valid, the surety pays the owner up to the bond amount. You must then reimburse the surety in full, plus legal fees and costs .
Q: Can I get a performance bond with bad credit?
Yes, but you will pay a higher premium. Sureties are more selective than insurers because they expect you to repay any claims. Poor credit may also result in collateral requirements.
Q: How much bonding capacity do I need?
Capacity reflects the total bonded work you can handle at once. It grows with experience, financials, and proven bonding performance. Most sureties will not bond more than 10-15 times your working capital.
Q: What is the difference between a performance bond and a contract bond?
Contract bonds are any type of surety bond used to ensure construction projects follow contract terms. A performance bond is a specific type of contract bond that guarantees satisfactory project completion .
Q: Do subcontractors need performance bonds?
Yes. Subcontractors may be required to provide performance bonds to the general contractor, especially on large public projects. The bond guarantees the subcontractor’s performance of their scope of work.
Q: What is the penal sum of a bond?
The penal sum is the maximum amount the surety will pay if the principal defaults. For performance bonds, this is typically 100% of the contract value .
5 Interesting Things About Performance Bonds Not in the Top 10 Sites
- Performance bonds originated in ancient Rome. Public works projects in the Roman Empire required contractors to post guarantees that they would complete the work—a direct ancestor of the modern performance bond system.
- Sureties can be exonerated if the owner interferes. If a project owner fails to allow a surety to exercise the options provided to it upon the principal’s default, the surety may be exonerated from any further obligations under its performance bond .
- Performance bonds can cover consequential damages. While many bonds exclude consequential damages, performance bonds can be drafted to secure recovery of liquidated damages and consequential damages in addition to actual damages that flow from a performance failure .
- The surety’s liability is capped at the penal sum. As with payment bonds, the penal sum of the performance bond is the limit of the surety’s liability. An exception exists for prejudgment interest when the obligee’s claim exceeds the penal sum and the principal is found liable .
- Performance bonds are not just for construction. Performance bonds are used in computer system acquisitions, software development contracts, and other non-construction contexts to guarantee that vendors and developers will perform their contractual obligations .
Conclusion
A performance bond is a surety bond that guarantees a contractor will complete a construction project according to the agreed-upon contract terms. It is a three-party agreement between the contractor (principal), project owner (obligee), and surety company. The bond is required by federal law on most public construction projects over $150,000 under the Miller Act, as well as on many state and private projects.
If the contractor defaults, the surety pays the owner up to the bond’s penal sum (typically 100% of the contract value) and then seeks reimbursement from the contractor. Premiums typically range from 1% to 5% of the bond amount for qualified contractors.
Performance bonds differ from payment bonds (which guarantee payment to subs and suppliers) and bid bonds (which guarantee bids during the bidding process). They can be structured as conditional or on-demand bonds, with different legal implications for each.
Before bidding on any government or large commercial project, check the contract documents carefully for performance bond requirements. The bond is not optional—it is a condition of starting work.
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