Performance bond

A performance bond is the project owner's protection against contractor default. If the contractor fails to perform, the surety must make the owner whole under the bond's terms. Typical remedies are to finance the original contractor to finish, hire a replacement contractor, or pay the owner the cost to complete, up to the bond's penal sum. The penal sum is usually 100% of the contract price. Common forms include the AIA A312 and the federal Standard Form 25.

Performance bonds are required on federal construction contracts above the Miller Act threshold, on many state and local public projects, and on private jobs when an owner or lender insists. They are usually issued with a payment bond. The surety prices the bond by looking at the contractor's financial statements, work in progress, experience and credit, which is the idea behind bonding capacity. The contractor and usually its owners sign a general indemnity agreement, so a bond is closer to credit than insurance: the surety expects repayment for any loss it pays.

The common misunderstanding is that a bond pays whenever a project goes badly. It does not. A claim usually requires the owner to give formal notice, declare the contractor in default and follow the bond's conditions. Owners who change the contract materially or release payments early without the surety's consent can weaken their own protection. The guide on bid, performance and payment bonds: how contract surety works explains the process, and what a surety bond costs and how it is priced covers pricing.