Bid, Performance and Payment Bonds Compared

Three bonds attach to a typical construction contract, and they are not variations on a theme. Each has its own obligee, its own triggering event, its own penal sum and its own class of persons entitled to enforce it. A claimant who pursues the wrong one is not merely inefficient; on public work the mistake can consume the short period within which the right claim had to be made.

The three-party structure

Every bond involves a principal who owes the underlying obligation, a surety who guarantees it, and an obligee for whose benefit the guarantee runs. The surety's promise is secondary in character, answering for the principal's default rather than assuming an independent duty to perform. This structure explains most of the doctrine that follows: the surety may generally raise the principal's own defenses to the underlying obligation, and the surety expects to be reimbursed by the principal for whatever it pays.

It also explains the underwriting. A surety does not price an expected loss in the way an insurer does. It evaluates the principal's capacity, capital and character, requires an indemnity agreement, and issues the bond on the expectation that no loss will ultimately be borne. Premium therefore reflects the cost of extending credit rather than the probability of failure, and a contractor unable to obtain a bond is generally unable to bid the work at all. That gatekeeping function is why bonding capacity, expressed as a limit per project and an aggregate across open work, operates as a practical ceiling on the size of a contractor's business.

The bid bond

A bid bond, called a bid guarantee in federal contracting, secures the bidder's promise that if awarded the contract it will execute the documents and furnish the required performance and payment bonds. If the bidder refuses, the surety answers for the difference between that bid and the price the owner must pay to the next acceptable bidder, up to the penal sum. Federal policy requires a bid guarantee whenever a performance bond or a performance and payment bond is required, subject to a narrow waiver by the chief of the contracting office.

The amount is customarily a percentage of the bid rather than a fixed sum, and the obligation is discharged on execution of the contract and delivery of the other bonds. Disputes on bid bonds are relatively rare and usually concern whether a bid may be withdrawn for a demonstrable clerical error before award, a question governed by the procurement rules rather than by suretyship principles.

Alternative forms of bid security are widely accepted. Certified checks, irrevocable letters of credit and, in some settings, deposits of government securities serve the same protective function and avoid the underwriting step. Federal rules permit several of these for supply and service contracts while restricting construction work to separate bid bonds, and allow agencies to insist on separate bid bonds alone. A bidder without an established surety relationship will usually find the alternatives more accessible, at the cost of tying up capital for the duration of the evaluation.

The performance bond

The performance bond secures completion of the work according to the contract, for the benefit of the owner. It is not triggered by delay, by disputes over change orders or by the contractor's financial difficulty. It is triggered by a declared default, and on federal work that ordinarily means a termination for default under the applicable clause. What the surety must then do, and the options available to it, are addressed separately in calling a performance bond after a default.

Penal sums are fixed by the contract documents. Federal construction contracts require a performance bond in the amount the contracting officer considers adequate, with the regulation setting one hundred percent of the original contract price as the ordinary figure and providing for adjustment where the price increases. The performance and payment bonds carry separate limits, so a large completion claim does not by itself reduce what is available to unpaid trades.

Two features of the instrument repay attention before a claim is made. The bond incorporates the underlying contract by reference, which means the contract's own notice provisions, cure periods and dispute clauses generally bind the obligee in its dealings with the surety. And the bond form itself may add conditions, such as a requirement that the obligee declare the principal in default in writing and agree to pay the balance of the contract price to the surety or a completing contractor. Failing to satisfy those conditions is one of the more effective defenses available.

The payment bond and who stands behind it

The payment bond secures payment to those who supply labor and material for the work. On federal projects the statute requires it for the protection of all persons supplying labor and material in carrying out the work, and gives each of them a direct right of action. It exists because a claimant on public work cannot place a lien on the improvement, so the bond substitutes for the security that would otherwise attach to the property. Which persons qualify, and on what conditions, is the subject of who may claim, by tier.

Finally, the identity of the surety matters. Bonds required by federal law must be issued by a corporate surety approved for that purpose, and the Treasury program that certifies acceptable companies publishes the list against which a contracting officer checks. Verifying that the surety appears on it, and that the bond amount falls within the underwriting limit shown for that company, is a routine step before relying on the instrument. The equivalent state requirements, and the statutes that impose them, are compared in little Miller Acts and where they diverge from the federal rule.