Payment and Performance Bonds Explained

Payment and Performance Bonds Explained

The two are an odd pairing—unique in their own way but dependent on each other. While payment and performance bonds have their differences, both are essential to protect yourself as an individual or even business owner. Let’s explore the differences.

Payment Bonds

In simple terms, a payment bond enforces that everything must be paid once a project is completed. Payment bonds are also surety bonds and are required for most state projects based on the Miller Act

The Miller Act was passed by the U.S. General Services Administration Public Buildings Service (GSA) with the intention to explain how payment bonds protect subcontractors and suppliers.

The GSA responds to any reports of nonpayment, following the legal action needed and protected by the Miller Act. The GSA states that “the Miller Act requires that prime contractors for the construction, alteration, or repair of Federal buildings furnish a payment bond for contracts in excess of $100,000.” 

Payment bonds additionally play a major role in construction. As an insurance company, we have relationships with carriers who understand the specifics of construction risk and can provide better solutions, better prices, and more comprehensive coverage—even for hard-to-place and high-risk companies.

This is where payment and performance bonds come into play. The reasoning behind payment bonds is protection. Investopedia states that “a payment bond guarantees a party pays all entities, such as subcontractors, suppliers, and laborers, involved in a particular project when the project is completed.”

There are legal consequences to breaking a contract through the Miller Act. The GSA expands on the topic: “Failure by a contractor to pay suppliers and subcontractors gives such suppliers and subcontractors the right to sue the contractor in the U.S. District Court in the name of the United States.” 

Performance Bonds 

The main differentiator between payment and performance bonds is that a performance bond ensures the employer is satisfied with the job. While both are surety bonds, performance bonds can be helpful in industries apart from construction. 

A performance bond, according to Investopedia, “ensures the completion of a project. Setting these two together provides the proper incentives for laborers to provide a quality finish for the client.” 

A performance bond has three parties involved: 

  • The principal is the primary contact in the performance bond and is responsible for performing the contract
  • The obligee is the person receiving the obligation
  • The surety is responsible for making sure each party complies with the performance bond obligations

Surety bonds are a line of credit granted to the principal to reassure the obligee that the principal will fulfill their side of the agreement. 

Often used in contracts where trust or relationships have not yet been established, surety bonds put the company’s financial well-being at risk. In these cases, the hiring entity can request that the contractor be bonded.

Competitive Edge Insurance offers various types of bond coverage. But remember, a surety bond is not an insurance policy. The payment made to the surety company is paying for the bond, however, the principal is still liable for the debt. Learn more about bond coverage by contacting Brenda Jo today.