A payment bond and performance bond are often confused because they're often purchased together.
But a payment and performance bond have different purposes. Each is easy to understand once you learn the purpose of a surety bond in construction projects.
Let's go through the difference between a payment and performance surety bond.
Why Are You Required To Purchase Construction Surety Bonds
A construction surety bond is a tool used by a project owner to manage the risk of the construction company failing to:
- Accept the project after winning the bid
- Complete the project according to the contract
- Pay for the services and supplies that help get the project done
And that's where the payment bond and performance bond differ.
The Payment Bond vs Performance Bond
The Payment Surety Bond
The payment construction bond is used by the project owner to ensure all service, supply, and material providers are paid for the services they complete to finish the project.
These parties typically include:
- Subcontractors
- Equipment providers
- Supply or material providers
With a payment bond, these third party providers can place a lien on the project and often do but ultimately they are paid by either the project or their claim on the payment surety bond.
If a subcontractor, equipment or material provider is not paid they have to make a claim against their hiring contractors payment bond for the financial damages they suffered.
So payment bonds not only protect these service providers but it protects the project ultimately from having these service providers locking down a project.
If a payment bond claim is legitimate and the hiring contractor can't pay, the payment surety bond will pay out the required funds.
The hiring contractor is responsible for paying back the surety (the insurance company that underwrote the bond) back the amount of the claim.
The Performance Surety Bond
The performance bond is used in the event of complete project failure or stoppage. This can happen because of:
- Mismanaged cash flows shutting the project down
- Management oversights
- Even environmental issues that force the local government to shut the project down
If the primary construction company is not able to complete the project the surety (the insurance company that underwrote the bond) typically takes one of the following actions:
- Provide the cash to the construction company to get the project to the finish line
- Take control of the project and find a contractor to complete the project
- Pay out the money to the project owner to find a new contractor to complete the project
There are other solutions to the problems and in many cases the exact solution depends on the reasons the project shut down.
To Recap a Payment Bond vs a Performance Bond
The payment bond is a tool used to pay subcontractors, equipment, or material providers in the event the hiring contractor does not pay them for services completed.
The performance bond is a toll used by the project owner (and surety) to get the project to completion in the event the primary construction company is unable to finish the project.
But You Purchase the Payment and Performance Bond Together
This is why these two bonds can get confusing, you purchase both of them at the same time for about 1% to 3% of the project total (your winning bid amount).
Remember, surety bonds are an assessment of risk and not individual policies like traditional insurance.
Plus think about the scenario if a construction project were to fail.
If a construction company fails to pay a couple subcontractors for work completed...
And they are ultimately unable to complete the project because of serious cash flow issues...
The performance bond would be triggered to get the entire project back on track. This effectively subverts the payment bond.
You Get Approved For Both Payment and Performance Bond From The Beginning
From the moment you construct a bid package for a project and you begin the construction bond process, you will:
- Purchase your bid bond
- Get approved for the performance bond
- Get approved for the payment bond
In most cases this pre-approval is a requirement. You may have heard of this called proof of bondability or having bond capacity.
Essentially the project owner wants to make sure if you're bid wins, there is no risk of you failing to secure the required performance and payment bonds.
Payment vs Performance Bonds For Government vs Private Construction Projects
Both payment and performance bonds have the same purpose whether the construction project is a government procured or private.
That does not mean that private project requirements can change. But from a pure purpose angle, there is no difference.
However the bid bond does have different rules. Make sure you read our bid bond post to learn all the rules from bid surety bonds.
Are You Ready To Establish an Aggregate Construction Bond Capacity?
If you're an emerging construction company, beginning to bid on larger projects it's a good idea to obtain a line of credit or a "letter of bondability."
(This is officially know as setting up a construction bond program.)
Think of this as an aggregate construction bond capacity saying, based purely on credit, you're approved up to X amount for construction bonds.
We are Surety Bonds Direct and we're able to get you approved for this line of credit up to $3 million dollars with nothing but a credit check of business ownership.
This does not mean you have to request $3 million dollars. You should select an amount that will match your company's capacity to get projects done and manage cash flows.
Typically this amount is 1.5x the largest project you've completed within the last 2 years.
Complete this form and tell us about your company or call a bond specialist today (1-800-608-9950) to get the process started. It only takes a few minutes to obtain the approval that's right for you.
Do You Need a Bid, Performance, and Payment Bond Now?
If you're actively putting a bid package together for a project, complete a bid bond quote request or call a bond specialist so we can get you approved - 1-800-608-9950.
If you have the following information, make sure you gather it. Every piece of information helps.
- Business financial statements (balance sheet and statement of cash flow)
- Details of the last project completed no matter how big or small
- Any past bond history you may of had
We hope to build a long term relationship with your company and help you scale your business to meet your goals.
