Performance Bond Basics

Performance bonds, usually accompanied by payment bonds, are the key protection offered the tax payer on public works project.  In the United States, public works projects are usually awarded based on the low bid.  If it were not for the performance and payment bond, what would stop a totally unqualified bidder from bidding on the project?

For instance, lets assume the city of Jonesville decides it needs a new water treatment plant.  The estimated cost of this plant is five million dollars.  The taxpayers of Jonesville want to make sure that they are getting the job at the lowest possible cost, so the job is put out to public bid.  This means any contractor can put in a bid on the job; if that contractor can post a surety bond.

Suppose there was not a requirement for performance and payment bonds.  The tax payers still want the project at the lowest possible cost so chances are the project would still be put out for public bid.  Bubba’s contracting looks at the plans, and even though Bubba has never built a water treatment plant before, he figures he has drank enough water to do a good job on it and he puts in a bid.  Because there is no bond requirement no entity, like the surety bond company,  is asking Bubba if he has ever built a water treatment plant before.  Bubba is the low bidder.

A few months go by and it turns out Bubba does not know what he is doing.  the work is not being done according tot the plans and specifications and Bubba decides to use one of the progress payments to buy a new top of the line, four wheel drive truck with a custom paint job, gold plated wheels and a lift kit. Soon there after, Bubba gets kicked off the job, subs and suppliers are not paid, and the taxpayers of Jonesville do not have a treatment plant.  The subs and suppliers cannot file a lien on public property so they take the town to court and win meaning not only does the town not have a treatment plant, the taxpayers are going to have to pay for the same work twice because no payment bond was required.

The surety bond companies primary responsibility is pre qualification .   Because public works jobs require bonding, a surety bond company would review the past experience of the bidders.  The bond company would make sure the bidder has the financial wherewithal to complete the project, and best part of all, would back up this pre-qualification with substantial financial resources.

Back to Bubba; if this were a bonded job and somehow Bubba convinced a bonding company he was qualified to do the project the end of the story would be a lot different.  The insurance company that provided the performance and payment bonds would have hired a new contractor to complete the job.  All of the subcontractors and suppliers that had worked on the job would have been paid and all of this, at no additional cost to the taxpayers.

This is the basic purpose of the performance and payment bond.