What Is a Contract Bond? Bid, Performance, and Payment Bonds Explained

What is a contract bond?

A contract bond is a type of surety bond that guarantees a contractor will meet its obligations under a construction contract. If the contractor fails, the surety steps in to compensate the project owner or unpaid parties, up to the bond's penal sum. Each bond is a unique guarantee for a specific contract. Multiple contracts can be bonded at once, but each one will need a specific bond. 

A contract bond is not the same as a contractor's license bond. These are bonds required by a state or city before a contractor can obtain a license to perform work in that location. Contractor's license bonds usually guarantee that a contractor will follow licensing laws and regulations, although some do provide blanket performance guarantees on all work a contractor undertakes under the corresponding license.

Every contract bond has three parties:

How contract bonds differ from insurance

Insurance protects the policyholder and expects losses due to unforeseen perils. A surety bond protects the obligee (not the principal) and expects no losses. Surety bonds function more like an unsecured line of credit than an insurance policy. Contractors that buy bonds must sign an indemnity agreement promising to make the surety whole if they default. That is why underwriting looks at the contractor's credit, finances, and track record rather than pooled risk.

Why project owners require contract bonds

• Protection against default: if the contractor defaults, the owner can recover the cost of finishing the work. Construction projects are capital intensive, and if a contractor fails to complete a job, it can jeopardize the owner’s financial health. This is the main reason project owners require contract bonds

• Pre-qualification: a surety only bonds contractors that it believes can finish the job. By requiring contractors to secure a bond, the project owner can filter out contractors that aren’t qualified to perform the work without having to underwrite them directly

• Lien protection: on public projects, where mechanics' liens usually can't attach to government property, payment bonds give subcontractors and suppliers a way to get paid

What is a bid bond?

A bid bond guarantees that a contractor who wins a bid will sign the contract at the bid price and provide the required performance and payment bonds. Bid bonds are submitted with the bid, prior to work being awarded. Some sureties may issue a preapproval first, and then individual bid bonds as needed, as long as the bid bonds are within the preapproval requirements.

• Who it protects: the project owner, against a low bidder who backs out.
• What happens on default: the surety typically pays the owner the difference between the defaulting bid and the next-lowest bid, up to the bond amount.
• Typical amount: 5% to 10% of the bid on many state, local, and private jobs. Federal solicitations require a bid guarantee of at least 20% of the bid price, capped at $3 million.
• Typical cost: many sureties issue bid bonds at no charge to contractors with an approved bond program, since the premium is earned on the performance and payment bonds that follow.

Example: A contractor bids $800,000 on a county road job with a 10% bid bond requirement. The bid bond's penal sum is $80,000. If the contractor wins but refuses to sign, and the next bid is $850,000, the surety covers the $50,000 difference and then seeks reimbursement from the contractor.

What is a performance bond?

A performance bond guarantees that a contractor will complete a project according to the contract's plans, specifications, schedule, and price. It is issued after the contract is awarded and before work starts.

• Who it protects: the project owner, against a contractor who is unable or unwilling to complete the work specified in the contract
• What happens on default: after the owner declares the contractor in default, the surety investigates. It may finance the original contractor to finish, bring in a replacement contractor, take over completion itself, or pay the owner up to the penal sum.
• Typical amount: 100% of the contract price. On federal work, the performance bond must equal 100% of the original contract price unless the contracting officer sets a lower amount, plus 100% of any price increases.
• Duration: in force through completion, and if the contract contains a warranty or maintenance period, the bond often continues until the end of this period.
• Typical cost: performance bonds usually cost between 0.5-3% of the bond amount. Well-qualified contractors generally qualify for lower rates and new businesses or businesses with poor financials may need to pay higher rates or post collateral with the surety

Example: A school district hires a contractor for a $1.2 million gym renovation, and requires the contractor to post a $1.2 million performance bond. The contractor walks off the job at 60% complete, after having received full payment from the project owner. The surety pays a new contractor $480,000 to finish the job, and pursues the first contractor to recover the loss. It’s important to note that even though the surety only paid $480,000 to finish the job, the bond would have paid up to the entire $1.2 million penal sum if necessary.

What is a payment bond?

A payment bond guarantees that the contractor will pay its subcontractors, laborers, and material suppliers on the project. Payment bonds are usually issued in combination with a performance bond for a project, although it is possible for payment bonds to be issued alone.

• Who it protects: subcontractors, laborers, and suppliers. Indirectly, it protects the owner from liens and disputes.
• Why it matters on public jobs: government property generally can't be liened, so the payment bond replaces lien rights for anyone who furnishes labor or materials.
• Typical amount: 100% of the contract price. On federal work, the payment bond must be no less than the performance bond.
• Duration: in force through completion of the project
• Typical cost: If they are required as a standalone bond, payment bonds usually cost between 0.5-3% of the bond amount. Since payment bonds are most often required in combination with a performance bond, sureties will issue combined “payment and performance” bonds that are a combined guarantee with a single premium that is usually between 0.5-3% of the bond amount.  Well-qualified contractors generally qualify for lower rates and new businesses or businesses with poor financials may need to pay higher rates or post collateral with the surety

Example: A concrete supplier delivers $40,000 of material to a subcontractor on a federal courthouse project and isn't paid. The supplier sends timely notice and files a claim against the prime contractor's payment bond, and the surety pays the claim after a review. The surety then seeks recovery from the bonded principal.

Bid bonds vs. performance bonds vs. payment bonds

Bid bonds provide assurance at the bidding stage, before the contract is awarded. The performance and payment bonds cover the duration of the contract. They are usually issued as a pair.

Other contract bonds you may see: maintenance (warranty) bonds, which cover defects after completion; supply bonds, which guarantee delivery of materials; and subdivision bonds, which guarantee a developer's public improvements.

When are contract bonds required?

Federal projects (the Miller Act). The Miller Act requires performance and payment bonds on any federal construction contract over $150,000. For contracts between $35,000 and $150,000, the contracting officer must select two or more methods of payment protection, which can include a payment bond. Bonds must come from a surety listed on the U.S. Treasury's Circular 570 (often referred to as a “T-Listed Surety”) to be acceptable financial assurance for a federal contract.

State and local projects (Little Miller Acts). Every state has its own version of the Miller Act for public works. These state-level laws include their own dollar thresholds, bond percentages, and claim deadlines. The threshold at which a bond is required varies from state to state, so contractors should check to verify this before they bid. Circle Surety has state-specific pages that provide more detail for each state.

Private projects. No law requires bonds on private work, but many developers, lenders, and general contractors require them in the contract. This is especially common for larger jobs or contractors they haven't worked with before.

Subcontracts. General contractors often require subcontractor performance and payment bonds to protect themselves if a sub defaults.

How much does a contract bond cost?

Most performance and payment bonds cost about 0.5% to 3% of the contract price. The premium is charged once (although it can be adjusted if change orders are required that increase the size of the job) and is usually calculated using a sliding scale where the rate decreases as the contract gets larger. Express programs, which are quick approval programs that offer expedited underwriting for small jobs, generally charge closer to a flat 3% rate. Larger or well-qualified accounts will usually have premium discounts applied. Bid bonds are often free.

The following is an example of what a well-qualified contractor may expect to pay when procuring payment and performance bonds:

 

In the example above, each rate applies only to the portion of the bond amount inside its tier. For example, the premium on a $1,000,000 contract is $2,500 on the first $100,000, plus $6,000 on the next $400,000, plus $5,000 on the remaining $500,000, for $13,500 in total. This equals an effective premium rate of 1.35%. Under the same rating schema, a $100,000 contract will cost $2,500, a $500,000 contract will cost $8,500, and a $2,000,000 contract will cost $23,500. 

What determines the cost of a contract bond:

• Personal and business credit of the owners
• Financial statements: working capital and net worth relative to the job size
• Experience: completed projects of similar size and type
• Work in progress: how much uncompleted work the contractor is already carrying
• Contract terms: duration, warranty period, liquidated damages

Smaller jobs can often be approved on credit alone. Larger programs typically require CPA-prepared financial statements. Circle Surety can approve applicants up for bonding lines up to $2,000,000 without financials.

How to get a contract bond with Circle Surety

Circle Surety is a surety bond wholesaler that works through licensed partner agencies to give contractors instant approvals for programs up to $2,000,000, full underwriting for larger accounts, and individual bid, performance, and payment bonds issued online in minutes. Every contractor is served by a partner agency, so you get the speed of an online platform and a licensed agent who knows your business.

1. Apply for your program approval. Apply once online, either on this page or on a partner agency's website. If you apply here, Circle Surety assigns you a partner agency automatically, with no need to find an agent first
2. Secure a program. Programs up to $2,000,000 in total bonded work are eligible for instant approval without financials. If you need more capacity, Circle Surety underwrites larger bonding lines with your partner agency
3. Request a bond for a specific job. When you have a bid or award, enter the project details and the bond type: bid, performance, payment, or maintenance
4. Receive your bond. Bonds are typically issued same day, ready to sign and submit to the obligee
5. Bond the next job. Circle Surety’s self-service portal tracks usage of a contractor’s bond line and allows contractors to request additional bonds as needed, minimizing back and forth and making the process fast and easy.

Why agents and contractors choose Circle Surety

Best for: small and mid-sized contractors bidding public or private jobs who need a fast approval, contractors who need a program but do not have prepared financials, and agencies that want to offer contract bonds without a long underwriting cycle.

For insurance agencies

Circle Surety is a wholesale contract bond market for independent agencies. Partner agencies can offer clients instant approvals up to $2,000,000 (with larger programs available) and streamlined bond issuance, without a long underwriting cycle. 

Add the Circle Surety storefront to your agency's website from your agency dashboard (Storefront > Embed), and your clients can get approved and bonded without leaving your page. 

Contract bond glossary

This guide is for general information and isn't legal advice. Bond requirements vary by contract and state.

Sources

• FAR 28.101-2, Bid guarantee amount
• FAR 28.102-1, Miller Act bond requirements
• FAR 28.102-2, Performance and payment bond amounts