Performance and payment bonds are types of bonds that are intended to protect the owner in a construction project from contractor failure. They are also used to protect the various parties to the construction party from instances of non-payment. Performance and payment bonds are also known as construction bonds.
Specifically, it is the Performance Bond that provides security on the contractor’s duties. These include promises to perform the construction within the time frame provided and at the agreed upon price. The Payment Bond protects the workers, suppliers of materials, and subcontractors from nonpayment by the contractor.
Performance and payment bonds were originally created to address the high rate of failure in construction projects sponsored by the federal government. Today performance and payment bonds are most commonly used in real property developments, such as the building of homes or other types of residences.
In general a “bond” is a written obligation to pay a fixed monetary sum on the happening or non-occurrence of a specified event or condition. In the case of performance bonds, the specified event that triggers compensation is if the project stops in the middle of construction before completion. In payment bonds, the specified event is the non-payment of workers or other parties.
Typically the contractor themselves will purchase a bond from an insurance company and pass on these costs to the project owner who hired them. In turn the insurance company will provide the project owner with monetary compensation for losses in the event that the project is not completed or if the parties are not paid properly. Thus, performance and payment bonds really focus on protecting the owner of the project rather than the contractor or the subcontracted workers.
Performance bonds and payment bonds can usually be costly for the contractors, who must take out a separate bond for each specific job. Bonds are more common with larger projects ranging from $25,000 and up. However, a contractor who has been approved with a bond company is generally considered to be more reliable than non-bonded construction operations.
- Complete the contract through a “completions contractor” who specializes in completing unfinished projects
- Select an entirely new contractor who will contract directly with the project owner
- Allow the owner to complete the project themselves, with the insurance bond company paying the costs
Alternatively, the owner of the project may wish to sue the contractor for the losses or to recoup the costs of wages and materials in the event of non-payment. Bonds can also be applied where the quality of work is very poor.
However, if the bond company has already rendered financial assistance to the owner, their amount of recovery in court may be reduced or even prohibited. Equitable remedies may be available instead such as an injunction which requires the contractor to make the payments or complete the work.
As you can see, construction projects can be very expensive and complex endeavors. They often involve several parties, sometimes more than five or six. These can include the project owner, the general contractor, the insurance bond company, any subcontractors, and material suppliers. Thus, it would be wise to consult with a business attorney if you feel that performance or payment bonds are needed. A lawyer can help protect your interests and they can draft a contract which outlines the bond provisions.