On any sizeable construction job, trust is not a plan. Owners need assurance that their project will get built even if the contractor falters, and contractors need a way to signal that they are capable, serious, and financially sound. Performance bonds sit right at that junction. If you have ever signed a prime contract on a public project, or acted as a subcontractor to a national general contractor, you have touched the world of performance bonds, even if only through their requirements in the bid documents.
This is a practical guide to what performance bonds are, how they work in the field, when they are required, and what they mean for both owners and contractors. It draws on the realities that show up after the ink dries: schedule pressure, cost creep, defaults that happen not with a bang but with a slow fade, and the knock-on effects when a bonded contractor collapses midstream.
The basic idea, without jargon
A performance bond is a three‑party agreement that guarantees the contractor will complete the project in accordance with the contract. The three parties are:
- Obligee, usually the project owner or upstream contractor who requires the bond. Principal, the contractor who purchases the bond and promises to perform. Surety, the bond company that backs the principal’s promise and steps in if the principal fails.
From the owner’s perspective, the performance bond is a safety net. If the contractor defaults, the surety funds completion or arranges another qualified contractor to finish the work. From the contractor’s perspective, the bond is not a pile of cash sitting in escrow. It is a contingent guarantee, and if the surety has to act, the contractor owes the surety for the losses. Most bond forms include a broad indemnity agreement that reaches into company and often personal assets of the owners.
Think of it as a credit-based guarantee, not insurance in the everyday sense. The surety underwrites you, then lends its balance sheet to your promise, and expects to be repaid if it has to perform.
Where performance bonds fit among other bonds
Performance bonds usually travel with two companions:
- Bid bond, submitted with the bid. It says that if you are low and awarded the job, you will sign the contract and provide the required performance and payment bonds. If you refuse, the surety pays the owner the difference up to the penalty amount, often 5 to 10 percent of the bid. Payment bond, issued alongside the performance bond. It guarantees that laborers, suppliers, and subcontractors get paid, limiting liens and protecting the owner from double payment.
On public work in the United States, payment and performance bonds usually come as a pair. Private owners may request only a performance bond, but more often they require both because unpaid subs are the tinder that sparks disputes and liens. In many other countries, the terminology shifts a bit. You will hear “bank guarantees” or “performance guarantees” instead of surety bonds, but the function is similar: protect the owner against nonperformance.
When performance bonds are required
Federal and state law drives many of these requirements. The U.S. Miller Act requires performance and payment bonds for federal construction contracts that exceed a modest threshold, historically $150,000 for performance bonds and $35,000 for payment bonds, though agencies can set higher internal thresholds. Nearly every state has a “Little Miller Act” that applies similar rules to state and municipal projects, sometimes with different dollar amounts. If you are bidding a school, courthouse, or highway job, expect to furnish bonds.
Private owners use bonds more selectively. Sophisticated developers and lenders often require bonds on larger vertical builds, especially when the general contractor is relatively small for the scope, the schedule is tight, or the design is complex. In multifamily and mixed-use, bonds show up when the capital stack includes institutional equity or a construction loan that mandates performance security. In industrial work, many owners replace bonds with parent-company guarantees if the contractor is part of a larger corporate group, or they require a letter of credit instead. Still, when the owner wants completion certainty without tying up its own capital, a performance bond is the common tool.
Subcontractors encounter performance bonds when they join major projects. A general contractor may flow down bonding requirements on critical trades such as structural concrete, steel, curtainwall, mechanical, electrical, and fire protection. The general’s own surety sometimes insists on these “subguard” practices, or the owner’s contract may require them for key scopes. If you are a specialty trade used to working only on private, smaller jobs, your first bonding request often lands when you step up to a large, schedule-driven project.
What a performance bond actually covers
Coverage flows from the bonded contract. If the contract requires you to build the structure to specific drawings and specs by a certain date for a fixed price, the performance bond guarantees that result. If the owner legitimately terminates you for default under that contract, and the surety has received proper notice and opportunity to respond, the surety owes a duty to act. That duty can be satisfied in a few ways:
- Finance the existing contractor so work can continue, often under a forbearance plan with close monitoring. Tender a completion contractor the owner approves, with the surety covering the cost gap up to the bond penal sum. Take over the project and manage completion itself, hiring a completion contractor directly. Pay the owner the damages up to the bond amount and step aside.
The bond limit, called the penal sum, is typically 100 percent of the original contract price, sometimes adjusted to include approved change orders. That limit is a cap, not a floor. If the cost to complete exceeds the penal sum, the owner’s recovery from the surety stops at the cap. Many disputes turn on delays, defective work, and scope alignment at the moment of default. This is the messy middle where good documentation, timely notices, and a clean project file matter. When an owner declares default but has not met prerequisites such as cure notices or has contributed to delays, the surety can push back.
What the performance bond does not do is cover every kind of loss. It does not pay for business interruption unrelated to completion, it does not guarantee profits beyond the contract, and it does not fix design errors unless the contractor took on that design risk. Performance bonds also do not replace warranties. After substantial completion, warranty obligations still belong to the contractor, although some bond forms extend liability if the contractor is gone and the surety funded completion.
How the underwriting works
Bonding capacity follows the old rule: the three Cs of surety - character, capacity, and capital. Translating that into the paperwork you will be asked for:
- Financial statements, ideally CPA‑prepared on a percentage‑of‑completion basis. Audited statements get more capacity than compilations. The surety looks for working capital, net worth, and a clean balance sheet. Work-in-progress schedule with realistic cost‑to‑complete forecasts, underbillings and overbillings, and backlog margins. Sureties smell trouble when underbillings grow and profit fades. Bank relationship and line of credit availability. A contractor who can absorb a draw slowdown or pay subs while chasing change orders looks safer. Resumes of key people, safety record, and evidence of systems. This is where character shows up: how you treat subs, how you handle claims, whether your schedules are believable.
For a new or growing firm, the first performance bond may be limited in size. Sureties will stair‑step capacity over time as the company closes jobs cleanly and strengthens its balance sheet. Many owners ask for licensed bonded and insured contractors because those three credentials together indicate a contractor is properly registered, carries required insurance such as general liability and workers’ compensation, and has a surety that underwrites their commitments. Licensure confirms legal compliance, insurance protects against accidental losses, and bonding adds financial assurance of completion.
The claims process in real life
No one wants to test the bond, but when a project stalls, practical steps matter more than labels. Owners need to follow the default provisions in the contract and the bond. Most standard forms, such as AIA A312, require a notice of default and an opportunity to cure before termination. Skipping those steps gives the surety an opening to deny or delay.
Once a claim lands, the surety investigates. Expect requests for the contract, change orders, progress payments, schedules, daily reports, and correspondence. The surety will talk to the owner, the contractor, key subs, and sometimes the architect. This takes time, often weeks for simple matters and longer for complex ones. Owners feel the schedule burn while waiting. Good communication helps. If you are the owner, present a clear record of the defaults and the costs to complete, not just frustration. If you are the contractor in trouble, be candid about the obstacles and what help would stabilize the job.
In many cases, the surety opts to finance the original contractor to finish. It is usually faster and cheaper than a takeover. That financing might come with a funds control service, joint checks to subs and suppliers, and weekly cost-to-complete updates. In more severe cases, the surety tenders a replacement contractor. The tendered firm must meet the contract requirements, and the owner must act reasonably in accepting. When the relationship has completely broken down, the surety can take over. That path is disruptive. It restarts site mobilization and brings new management who must learn the job under pressure.
Practical examples from the field
Consider a mid‑sized general contractor awarded a $14 million municipal library. The city requires a 100 percent performance and payment bond. Halfway through, the contractor experiences cash strain from two other jobs with delayed payments. Subs on the library start slowing down. The owner issues a notice to cure, and the contractor’s surety is looped in. The surety reviews the work‑in‑place and the remaining scope. Rather than letting the job slide into termination, the surety agrees to a funds control arrangement, pays subs directly with joint checks, and keeps the original superintendent and PM in place. The library opens six weeks late but within the bond penal sum. The contractor signs a repayment plan with the surety that stretches over three years.
Change the facts slightly. A specialty façade subcontractor bonded for $3.2 million falls behind because its overseas vendor fails to deliver custom curtainwall units. The general contractor issues multiple cure notices, then terminates for default. The surety tenders a replacement façade contractor at a higher price. The surety covers the difference up to the penal sum and later pursues indemnity from the original sub. The GC and owner lose time, but the building envelope is eventually completed, and interior trades get back to work.
In both stories, the bond did not erase pain. It did create a framework and funding path to finish the work, which is the core purpose.
Costs and how to manage them
Performance bond premiums on construction projects usually fall in a band of about 0.5 to 3 percent of the contract price, tapered by size. Smaller contracts cost more per dollar because fixed underwriting and administrative costs loom larger. Larger jobs, especially for established contractors with clean financials, can land below 1 percent. Many sureties use rated schedules with sliding scales, where the first $500,000 is priced higher, the next $2 million lower, and so on.
Premiums get baked into bids. Owners who ask, “Who pays for the bond?” should understand they do, indirectly, because the contractor includes the premium as a project cost. The more important question is value. A performance bond is cheaper than tying up an equivalent amount of capital in a letter of credit, and it paints a different risk picture. A letter of credit is a bank instrument. If called, the bank pays immediately and then pulls cash or restricts credit from the contractor. A performance bond requires a default and an investigation, which preserves flexibility. On the other hand, banks will sometimes extend larger LOCs to contractors with strong collateral, while sureties cap bonding capacity based on underwriting and history.
Contractors can lower bond costs over time by improving working capital, reducing aged receivables, keeping clean claims histories, and building disciplined project controls. Presenting accurate WIP schedules matters more than contractors like to admit. Overstated profits followed by write‑downs terrify sureties. A steady record of finishing on time and paying subs strengthens the story far more than glossy marketing.
How performance bonds intersect with contracts
The bond’s obligations are tied to the underlying contract terms, so the contract itself is not just legal boilerplate, it is the blueprint for what the surety must guarantee. Two contract features matter in particular.
First, termination and default provisions. They set the triggers for the surety’s duty to act. Vague or overly aggressive default rights create friction. Clear steps, notice periods, and cure opportunities reduce disputes. If you are the owner, follow those steps. If you are the contractor, understand them before you sign, and push for fair cure windows that reflect real procurement and schedule constraints.
Second, changes and time extensions. Most projects shift after award. Make sure approved change orders increase the bond penal sum where appropriate, or the owner may discover the cap is stuck at the original price while the project grows. Likewise, document time extensions for weather or owner‑initiated changes. Otherwise, liquidated damages claims can balloon and complicate any bond claim.
On the private side, some owners insert “subcontractor default insurance” in place of bonding subtrades. SDI, often branded Subguard, is a first‑party insurance product for the general contractor. It can be faster to administer than calling a surety for multiple sub defaults, but it does not give the owner a direct right against a surety. Each tool has its place. On public work, SDI is typically a supplement, not a substitute, because statutes require surety bonds.
The owner’s perspective: when to insist on a performance bond
Not every job justifies a bond. On a small tenant improvement with a trusted contractor and simple scope, the premium and paperwork may outweigh the benefits. On a complex Axcess Surety project with multiple critical paths, imported materials, or a thin schedule float, the bond’s completion guarantee is worth the cost. New owners sometimes think bonding a contractor will “make them behave.” That is not the right lens. A performance bond cannot manufacture competence, but it can backstop failure.
Practical indicators that push toward bonding include:
- Public funds or grants that mandate bonding by statute or policy. A contractor whose size is stretched by the project scope or whose balance sheet is thin. Long-lead materials and vendor reliance where a slip would cascade through the schedule. A lender that requires performance security as a condition of the loan. A project delivery method that concentrates risk on the contractor, such as fixed-price design-bid-build with tight liquidated damages.
Owners should also verify that the bond is genuine. Surety fraud exists. Request the bond from an established carrier listed on U.S. Treasury Circular 570 for federal work, or from a reputable surety rated by AM Best. Confirm with the surety that the bond was issued. Your contract should require the contractor to be properly licensed and insured as well. Many procurement teams state a preference for licensed bonded and insured contractors because it simplifies due diligence and ensures that basic protections are in place.
The contractor’s perspective: preparing to be bondable
If you plan to grow beyond small private work, start building a relationship with a surety agent early. Your agent will help right-size your first bond request and guide you on the housekeeping that underwriters scrutinize. Take financial reporting seriously. Hire a construction‑savvy CPA who understands percentage‑of‑completion accounting, billing curves, and retainage. Keep a rolling 12‑month cash flow forecast. Manage change orders actively and bill promptly. Pay attention to your indemnity agreements. Many small contractors sign personal indemnity without realizing its reach. That is not inherently bad, but you should weigh it when taking on risk.
A word on insurance: surety bonding is not a substitute. General liability, workers’ compensation, builders risk, and professional liability if you take on design are separate tools. Owners who demand licensed bonded and insured contractors are asking for a contractor who meets legal requirements, carries the standard insurance portfolio, and brings a surety’s guarantee to the table. If you check two boxes but not the third, you may lose bids where the owner values full risk management.
Common pitfalls and how to avoid them
Two patterns show up again and again in performance bond claims. The first is slow, unmanaged cash bleed. Margins bid too thin, procurement delays, and unrecognized scope creep combine to choke cash. Work slides, subs get anxious, and the owner loses faith. By the time the surety is notified, the path back is hard. Early warnings help. If you see WIP underbillings expand month after month, change orders stuck in limbo, or supplier terms shortening, treat it as a flashing yellow light. Engage your surety agent before it becomes red.
The second is paperwork complacency. Contracts require notices for changes and for delays. Field teams often prioritize production over documentation. That is understandable on a frantic job, but it can kill your position if a dispute goes formal. Teach supers and PMs to send short, timely notices that preserve rights without turning every day into a claim. When a bond claim arises, that trail becomes the difference between a quick surety decision and a slog.
Owners make mistakes too. Terminating in anger, skipping cure periods, or refusing reasonable tendered completion plans can reduce recovery. The surety is not the adversary when a job goes sideways. Their incentives align with finishing the work efficiently. Push them, but work with them.
International and private variants
Outside the U.S., you may encounter bank guarantees more often than surety bonds. These are on-demand instruments in some jurisdictions, which means the owner can draw without proving contractor default in the same rigorous way required under most U.S. surety forms. That speed comes with harder impacts on the contractor’s liquidity, since the bank treats a draw as an immediate liability. Some multinational owners prefer on-demand guarantees for that reason. Contractors negotiating these should fight for conditional wording where local law allows, or for lower percentages of the contract sum, such as 5 to 10 percent, paired with retention.
In domestic private work, letters of credit are the closest analog. Owners might accept an LOC in place of a bond from a contractor with a strong banking relationship but limited bonding capacity. Read the draw conditions carefully. An LOC that can be drawn upon simple owner certification is functionally on-demand. That may be acceptable in exchange for a lower price, but it shifts risk heavily to the contractor.
How bonds affect project relationships
When a performance bond is in place, everyone behaves a bit differently. Subcontractors feel more secure about payment when a payment bond is paired with the performance bond, which can help on tight labor markets. Lenders and equity see reduced completion risk, sometimes lowering financing costs. Owners sometimes, mistakenly, relax their own project controls because they believe the surety will fix everything if it goes wrong. That is not how it works. Strong owner oversight still matters. A surety steps in after default, not before. Early progress meetings, schedule tracking, and prompt decisions on RFIs and changes do more to keep a job on track than any bond.
For contractors, bonding disciplines growth. You cannot leap from a $2 million annual volume to a $20 million one without either building capital or rethinking the plan. Sureties will push back if your backlog triples in a quarter. That resistance can feel frustrating, but it prevents overextension. The contractors who survive downturns are usually the ones who listened to those constraints, even when the market was booming.
A brief word on form selection
Not all bond forms are equal. Industry-standard forms like AIA A312 or ConsensusDocs have balanced default procedures and clearly defined surety options. Some private owners produce custom forms that tilt obligations heavily, for example by allowing termination Axcess Surety reviews without cure or by imposing unbounded delay damages on the surety. Most reputable sureties resist extreme forms or price them accordingly. As a contractor, do not ignore the bond form during negotiation. It is part of the risk equation. If the owner insists on a harsh form, document the cost and schedule risks it creates. If you are the owner, favor clarity over leverage. Ambiguous or punitive forms are litigation fuel.
What to do next if you are approaching a bonded job
If you are an owner planning a project above the public thresholds or one that your lender will scrutinize, decide early whether to require performance and payment bonds and at what levels. Loop your counsel and your lender into the decision. Pick a bond form that fits the contract. Verify the surety’s credentials, and ask the contractor for evidence that they are licensed, bonded, and insured in your jurisdiction.
If you are a contractor pursuing bonded work for the first time, line up a surety agent and begin the underwriting process before bid day. Gather financial statements, WIP schedules, bank references, and resumes of key staff. Be ready to explain your plan for the job, including long‑lead items, staffing, and cash flow. Price the bond premium into your bid. Prepare your field team for the documentation discipline the bond world expects.
If you are an established contractor, take a hard look at your bonding capacity against your forecasted backlog. Sequence awards so you do not choke your capacity on a handful of low‑margin jobs. Keep communication open with your surety when delays or claims loom. Surprises are what break trust with underwriters.
The bottom line
Performance bonds exist to guarantee completion, not to guarantee perfection. They work best when paired with realistic budgets, honest schedules, and disciplined project management. Owners should use them where the stakes justify the premium and should respect the process embedded in the bond and the contract. Contractors should see bonding as a long‑term relationship with a financial partner who rewards transparency and consistency.
The label matters less than the function. Whether you are hiring or competing as licensed bonded and insured contractors, the goal is the same: build the project as promised, pay the people who make it happen, and finish strong enough to do the next one. A performance bond will not do that work for you, but when the unexpected hits, it can keep the work moving and protect the project everyone depends on.