Performance Bonds

Performance Bonds are a three-party guarantee where the Surety (Bond Company) provides a guarantee to an Obligee (Owner or Another Contractor) that their Principal (Contractor Providing the Bond) will complete the project according to the terms of the contract.

In layman’s terms, the performance bond is guaranteeing that you are going to complete the contract without any problems. Below is a chart showing the parties to a performance bond and how they work.

Who Needs Performance Bonds?

The Miller Act requires performance bonds equal to 100% of the contract amount to be issued on all Federal construction projects over $150,000. Most states and municipalities have adopted “Little Miller Acts” that require performance bonds on state and local projects as well. The performance bond in combination with the payment bond provide a means for protecting the project from mechanics liens of subcontractors and suppliers.

Additionally, private owners may require performance bonds on their projects to make sure they get completed without additional costs. Also, Contractors may require performance bonds from their subcontractors as a way to manage risk and to ensure that the subcontract work gets completed.

How Do I Get a Performance Bond?

In most cases, companies with good credit can get performance bonds up to $500,000 freely with a simple application. Larger bonds may require additional information and our staff are happy to help you through the process. You can also see our case study on performance bonds to see how underwriters look at larger projects. Although each performance bond is different, the below table shows what scope of financial information is needed for different projects.

The better the quality of the financial statement, the performance bond better rate the contractor will qualify for. In many circumstances, the better bond rate more than offsets the additional cost of the CPA. For contractors who need more than 1 or 2 performance bonds per year, a CPA prepared statement will more than pay for itself. In addition to the Corporate financial statements, usually the following will be required on larger projects:

• A personal financial statement on any owner owning more than 15% of the stock

• A completed application

• A copy of the contract to be bonded (A performance bond guarantees the performance of the contract so the surety bond company will want a copy of the contract before issuing the performance bond.)

You can learn more about underwriting Performance Bonds and other Contract Bonds here.

What If I Have Bad Credit?

At some point, many great companies and owners have had setbacks. Not to worry. MG Surety Bond works with all major surety bond companies as well as specialty surety bond companies. Credit is an important piece of the underwriting process but not the only piece. We will work with you and the company to find a solution everyone is comfortable with. In rare circumstances, we have other tools that can help contractors with credit challenges including access to the SBA Bond Guarantee Program, Funds Control and Collateral Programs. There is rarely a situation when we cannot provide a solution. Unlike some internet companies, we are surety bond experts first. It’s one of the reasons we have been so successful.

What Does a Performance Bond Cost?

The cost of the bond is based on the contract price, scope of work and strength of the contractor. Typically, this ranges anywhere from 0.5%-4%. Often the performance bond rate is on a sliding scale so that the percentage get smaller as the job get bigger. For example, a standard sliding rate for a General Contractor performing “Class B” work would be as follows:

In the example above, a $1,000,000 would cost $13,500 or 1.35%. The calculation is as follows:

($100,000/$1,000) x $25 = $2,500

($400,000/$1,000) x $15 = $6,000

($500,000/$1,000) x $10 = $5,000

      $13,500

Each surety bond company has many different rates and these amounts can be higher or lower depending on the contractor and the class of business. What is not included here are maintenance rates, design-build rates or time surcharge rates.

• Maintenance Rates – Most bond companies will include 12 months of maintenance in the premium. Some bond companies will include 24 months. Anything over that is charged an additional maintenance premium. These rates are generally very low.

• Design Build Rates – Every bond company looks at Design-Build projects a little different but most companies will have a higher rate for design build contracts. Information on bonding Design Build projects can be found here.

• Time Completion Surcharges – Most bond companies will have an additional charge for any contract that takes more than 12 months to complete.

A good surety bond broker can give you all the rates and costs before issuing the performance bond. You can get a full view of performance bond rates and how to improve them here.

How Is A Performance Bond Related To a Payment Bond?

Where as a performance bond guarantees the completion of the contract, a payment bond guarantees that subcontractors and suppliers will be paid. You can find more information on our Payment Bond Page. Payment bonds are also required on all Federal projects as well as by most states and municipalities. There is not an additional cost for a payment bond if a performance bond is issued. In essence, the Obligee gets double the protection for one cost.

Indemnity Required

Surety bonds are written on the principal of indemnity. This means that if the performance bond company suffers a loss, they will seek reimbursement from the indemnitors. Before getting a performance bond, the contractor and often the owners will be asked to sign a General Indemnity Agreement. You should read this agreement carefully before signing it. This agreement spells out the terms and conditions for the surety bond company, and all indemnitors. This is one major difference between surety bonds and insurance. Contractors can read more about indemnity here.

When Would Someone Make a Claim on a Performance Bond?

Most performance bonds require that Principal on the bond be in “default” and the contract be terminated by the Obligee to trigger a performance bond claim. The default can be voluntary or involuntary. An involuntary default occurs when the Principal is out of compliance with the bonded contract and the cannot or will not cure the problem with the Obligee. The Obligee then notifies the Principal and their performance bond company of the default. A voluntary default is similar except it is triggered by the Principal letting the performance bond company know that they cannot complete the contract.

Once the Principal is in default, the performance bond company will investigate the claim. Should the claim be found valid, the surety bond company has several options available to them. These include:

• Finance the Contractor

• Tender New Contractor

• Takeover

• Allow Obligee To Complet

• Write a Check for the Penal Sum

• Deny the Claim

More information on performance bond claims can be found here.

What Are Some Alternatives to Performance Bonds?

There are a couple of alternatives to providing a performance bond on a project.

• Irrevocable Letters of Credit – A contractor can typically substitute an Irrevocable Letter of Credit (ILOC) for 100% of the cost of the contract. Contractors would be wise to look at different alternatives. Unlike other products, these can be pulled on demand and the contractor will be left with few defenses to recover the money. A detail comparison of Performance Bonds and ILOCs can be found here.

• Subcontractor Default Insurance – This is often referred to in the industry as “Subguard” which is the name of Zurich’s product. However, several other carriers have entered this market with similar products of different names. Unlike performance bonds, this is insurance for subcontractor default. At this time, this product cannot be substituted for performance bonds on public work but many private projects are using SDI. A detailed breakdown of Subcontractor Default Insurance vs. Performance Bonds can be found here.

Other Performance Bond Questions

Please visit our Performance Bond Frequently Asked Questions page here for more information.