What Are Performance Bonds?

A performance bond is a financial guarantee that ensures the project owner is protected if the contractor cannot complete the project as agreed. A common question that arises is how is a performance bond different from a labor and materials bond—while a performance bond covers the completion of the project, a labor and materials bond ensures that subcontractors and suppliers get paid. This failure could be due to the contractor going out of business or not meeting their promises. Performance bonds are commonly used in construction but can also be applied in many other sectors.

How Do Performance Bonds Work?

A performance bond involves three parties:

• The contractor (the one doing the work),
• The project owner (the one paying for the work), and
• A third-party bond provider (usually an insurance or surety company).

The bond assures that the contractor will complete the project as agreed and to the required standard. If the contractor fails to deliver, the bond provider steps in to support the project owner—either by covering the financial loss or by arranging for another contractor to complete the work. To get a performance bond, the contractor must apply through a surety or bonding company. The bond provider will review the contractor’s financial status, previous work experience, and overall capability to complete the project. If approved, the bond is issued. Usually, the bond lasts about two years, but this can vary depending on the project.

Benefits of Performance Bonds

Performance bonds offer benefits to both parties:

• Project owners obtain peace of mind knowing the project will be completed or they’ll be compensated.
• Contractors show their reliability, which helps them win new contracts.

While the law doesn’t require performance bonds, many clients do. It’s often a condition for getting the job. Therefore, having a performance bond can give contractors a competitive edge.

Who Pays for the Bond?

The contractor pays for the performance bond. In some cases, they may include this cost in the overall project cost, depending on the agreement with the client. If it’s a subcontractor providing the bond, the main contractor will be the one to benefit from it.

The cost of a bond depends on:

• The contractor’s financial health,
• The size and complexity of the project, and
• Current market conditions.

Typically, the bond guarantees about 10% of the overall contract value. This helps cover damages, redoing faulty work, or hiring new contractors if the original contractor fails to deliver.

Types of Performance Bonds

There are different types of performance bonds:

• On-demand bonds: Paid out immediately when claimed, without needing proof.
• Conditional bonds: Require proof that the contractor failed to meet their duties.

Other related bonds include:

• Retention bond: Replaces money the client holds in case of faulty work.
• Advance payment bond: Ensures equipment paid for in advance is used properly.
• Section bond: Covers damage to public infrastructure during a project.

Performance Bond vs Bank Guarantee

Performance bonds work like guarantees. But using a bond provider (instead of a bank) can keep the contractor’s credit lines open for other uses.