Date Published: June 8, 2025
Surety Bonds 101 for Contractors: Demystifying Performance and Payment Bond Applications
For many contractors, especially those eyeing public works or larger private projects, the terms “Performance Bond” and “Payment Bond” often come up. While they might sound complex, understanding these essential financial tools is key to securing contracts and ensuring project success.
Think of surety bonds not as insurance for you, the contractor, but as a guarantee for the project owner and those who contribute to the project. They provide a vital layer of financial security, ensuring that if something goes wrong, the project can still move forward.
What are Performance Bonds?
A Performance Bond is a guarantee from a surety company to the project owner (the “obligee”) that you, the contractor (the “principal”), will complete the contract according to the agreed-upon terms, specifications, and timeline.
In simpler terms: If, for unforeseen reasons, you are unable to fulfill your contractual obligations (e.g., you abandon the project, go bankrupt, or fail to meet quality standards), the performance bond ensures the project owner won’t be left in the lurch. The surety company would then step in to ensure the project is completed, either by finding a new contractor or providing financial compensation to the owner.
Why are they important?
- Protects Project Owners: Mitigates financial risk for the owner in case of contractor default.
- Ensures Project Completion: Provides a mechanism to get the job done, even if the original contractor falters.
- Builds Trust: Demonstrates your commitment and financial stability to potential clients.
What are Payment Bonds?
Closely related to performance bonds, a Payment Bond guarantees that subcontractors, laborers, and material suppliers involved in the project will be paid for their work and materials.
In simpler terms: If you, as the general contractor, fail to pay your subs or suppliers, the payment bond ensures they will still receive their due. These parties can then file a claim against the payment bond to recover their funds from the surety company.
Why are they important?
- Protects Subcontractors and Suppliers: Ensures those contributing to the project are compensated, fostering a healthy working relationship.
- Prevents Liens: In many cases, payment bonds can prevent mechanics’ liens from being placed on a private (not public works) project.
- Maintains Project Flow: Reduces disputes and ensures materials and labor keep flowing, preventing project delays.
The Three Parties of a Surety Bond
Every surety bond involves three distinct parties:
- The Principal: This is you, the contractor, who is required to obtain the bond and whose performance or payment is being guaranteed.
- The Obligee: This is the party requiring the bond, typically the project owner (e.g., a government agency, a private developer, or a general contractor requiring a bond from a sub).
- The Surety: This is the bonding company (often an insurance company) that issues the bond. They guarantee the principal’s obligations to the obligee.
It’s crucial to understand that if the surety has to pay out a claim, they will seek reimbursement from the principal. A surety bond is more like an extension of credit or a co-signed loan, not like traditional insurance where you pay a premium and the insurer takes on the risk without repayment.
See our “What is a Surety Bond” Video.
How to Apply for Performance and Payment Bonds
The application process for performance and payment bonds is thorough, as the surety company needs to assess your capability and reliability. While the specific requirements can vary based on the bond amount and the surety company, here’s a general overview of what you can expect:
- Determine Your Bonding Needs: Project Requirements: Understand the specific bond amounts (often 100% of the contract value for both performance and payment bonds) and any other requirements specified in the project bid documents. Federal/State Regulations: For public projects, laws like the Miller Act (for federal projects over $150,000) mandate these bonds. Many states and municipalities have similar requirements.
- Choose a Reputable Surety Partner: Experienced Broker: Work with a surety bond broker or agent who specializes in contract bonds and has a deep understanding of the construction industry. They can guide you through the process and match you with the right surety company. See our Benefits of working with a surety bond only agency blog.
- Licensed Surety: Ensure the surety company is licensed and authorized to write bonds in your state and is financially sound (often rated by agencies like A.M. Best). Surety1.com only represents licensed, “A” rated surety bond companies.
- Gather Required Information (The “Three Cs”): Sureties evaluate what’s known as the “Three Cs” of underwriting:
- Character: This refers to your reputation, integrity, and track record.
- Resumes of key personnel
- Client references
- Work in Progress (WIP) schedules (detailing current projects)
- Completed job references
- Business continuity plan
- Capacity: Your ability to perform the work.
- Experience with similar projects in scope and size.
- Availability of equipment and labor.
- Organizational structure and management
- Strategic plan for future growth
- Capital: Your financial strength.
- Business financial statements (balance sheet, income statement, cash flow statement) – often prepared by a CPA for larger bonds.
- Personal financial statements for all owners.
- Bank references and lines of credit
- Tax returns (business and personal)
- Submit Your Application: Your surety broker will help you compile and submit the comprehensive application package to the surety company. This is where your detailed financial and project information becomes critical.
- Underwriting and Approval: The surety company’s underwriters will review your submitted documents to assess the risk involved. They’ll look for:
- A strong credit score (personal and business)
- A history of profitable projects
- Adequate working capital
- Clear financial reporting
- Absence of significant liens, judgments, or bankruptcies
For smaller bonds (often up to $1 million), some sureties offer streamlined “fast track” programs that rely more heavily on personal credit scores. For larger or more complex projects, a full underwriting review is standard.
- Receive Your Bond: Once approved, you’ll receive a bond quote and the bond documents. After you pay the premium (typically 1-3% of the bond amount, depending on your qualifications and the project), the surety will issue the bond to the obligee.
Demystifying the Process
While the information requested can seem extensive, remember that it’s all part of the surety’s due diligence to ensure you’re a reliable contractor. A well-prepared application demonstrates your professionalism and significantly speeds up the process.
Key Takeaways for Contractors:
- Start Early: Don’t wait until the last minute to apply for bonds.
- Be Prepared: Organize your financial and project documentation.
- Partner with Experts: A specialized surety bond professional can be an invaluable asset in navigating the application process and securing the bonds you need to grow your business.
Understanding and successfully acquiring performance and payment bonds is a critical step for any contractor looking to take on larger, more profitable projects. It’s an investment in your company’s credibility and a safeguard for project success.
About Surety1.com
Surety1.com is a service of AssuredPartners one of the largest and fastest growing insurance agencies in the nation. Representing over a dozen surety bond companies, Surety1.com is the premier provider of surety bonds for the construction industry, nationwide, since 2003.
About the Author
With a career spanning back to 1987, John Page is a seasoned veteran in the surety bond industry. He brings executive-level insight from his time as a Vice President at a top 10 national surety company, in addition to his entrepreneurial success as the founder and former president of Surety1.
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Surety1 was founded in 2003 and helps thousands of clients find the best prices on their surety bonds. We take pride in our work so that we can give you great service. Learn more about Surety1.