One paper can be both a payment bond and performance bond.
It is possible for one writing to be both a payment bond and performance bond. It all depends on the wording of the document.[1]
There is sometimes confusion on the part of suppliers and contractors about the different types of construction industry bonds. In a payment bond, the surety provides security that all persons supplying labor and material to the project will be paid. In a performance bond, the surety provides security that the principal will perform all of its contract obligations in a timely and workmanlike manner (finish the building in a timely and workman like manner). A bid bond provides security to the obligee/owner that if a contract bid is awarded, the owner will obtain a contract with that bidder to have the work completed at that bid price.
These three types of bonds often come together, with the payment of a single premium, but not always. Public bonding statutes usually require the contracting officer to get all three of these bonds. However private owners always have the option, and public owners sometimes have the option, of asking for only a performance bond to make sure the project is completed. This provides no payment protection to make sure all subcontractors and suppliers are paid. Suppliers and contractors sometimes hear that “there is a bond” or that “this job is bonded” and make the mistake of thinking this means they will have payment protection.
The title on the document does not usually matter. The initial paragraph(s) usually just identify the project, the owner, the contractor, and the bonding company. You have to read the “operative” language, often coming after “NOW THEREFORE, THE CONDITION OF THIS OBLIGATION is such that . . .” Look in the body of the paper to see what obligation the signatory is taking.
NOW, THEREFORE, THE CONDITION OF THIS OBLIGATION is such that
Section 1. (i) if Principal shall well and fully perform all of the undertakings, covenants, terms, conditions and provisions of the Agreement within the Contract Time . . . . . .and any warranties or guarantees contained in or required in the Agreement and . . . shall also any and all Change Orders or Addendum that may hereafter be made, and (ii) if Principal shall promptly make payment to all Claimants (as hereafter defined), for all labor, and Materials (as hereinafter defined) . . . . . then this obligation shall be null and void - otherwise it shall remain in full force and effect subject to all of the terms and provisions herein.
This bond is undertaking both performance and payment obligations.
Payment Bond
In a payment bond, the surety provides security that all persons supplying labor and material to the project will be paid. Subcontractors and suppliers are the “beneficiaries” of a payment bond. They do not require the bond. They are not parties to the bond but are third-party beneficiaries. However, the payment bond ensures that subcontractors and suppliers will be paid so that the obligee does not have risk of claims or mechanic’s liens if the principal fails to pay. If the principal defaults, beneficiary subcontractors and suppliers usually have the right to sue the surety directly for payment.
Performance Bond
In a performance bond, the surety provides security that the principal will perform all of its contract obligations in a timely and workmanlike manner.
Usually, a performance bond is only for the benefit of the obligee/owner of the construction project. If the principal defaults, the obligee/owner can require the surety to complete the project or to pay for the costs of completion. Subcontractors usually do not have the right to seek payment from the performance bond surety if the principal defaults.
A general contractor can require a subcontractor to obtain a performance bond as security that the subcontract will be completed in a timely and workmanlike manner. In this case, only the obligee/general contractor can require the surety to complete the subcontract work or to pay for the costs of completing the subcontract work.
Bid Bond
A bid bond provides security to the obligee/owner that if a contract bid is awarded to the principal, the obligee/owner will obtain a contract with the principal to have the work completed at that bid price. If the principal fails or refuses to enter into a contract for the bid price or to provide any required performance and payment bonds, the surety will be responsible for any costs incurred in rebidding the project and any increased contract costs. An owner can require bid bonds from all general contractors bidding on a project. A general contractor can also require bid bonds from all subcontractors bidding to the obligee/general contractor.
Mechanic’s Lien Bond
A mechanic’s lien bond is usually provided in connection with a court proceeding by a real estate owner or a general contractor to “bond off” a mechanic’s lien. A real estate owner or a general contractor can remove a mechanic’s lien from the land records by “bonding it off.” The surety promises to pay the mechanic’s lien claimant if the mechanic’s lien is later proven valid. The mechanic’s lien claimant is thus provided alternative security for the claim. The claimant no longer has the right to go against the real estate to obtain payment but can now go against the bond instead. This is discussed in greater detail in the chapters on mechanic’s liens.
PERFORMANCE BONDS
The performance bond is for the benefit of the bond obligee, providing security that the contract or subcontract will be completed in a timely and workmanlike manner.[2] In a Miller Act or Little Miller Act project, the bond obligee is the government owner. A private owner could also require a performance bond from the general contractor. A general contractor could require a performance bond from a subcontractor. Whoever requires the bond is the “obligee,” who is the only beneficiary of the bond. Whoever supplies the bond to the obligee is the bond “principal.” In the event of default on the contract, the surety can usually either take over and complete the project or allow the bond obligee to complete it and the surety would pay the costs incurred.
Only the bond obligee can make a claim under a performance bond for completion of a project. Suppliers of labor and material can seek payment only under the payment bond.[3] However, the payment bond and performance bond are sometimes included in one document.[4] Especially in a private project, it is important to read the operative language in a payment or performance bond. It does not matter that the title of a document is “Performance Bond.” If the operative language guarantees payment to all subcontractors supplying labor or material to the project, then subcontractors and suppliers will have a claim under the bond.[5]
[1] Phoenix Ins. Co. v. Lester Bros., Inc., 203 Va. 802, 127 S.E.2d 432 (1962); Mayor of Baltimore v. Fidelity & Deposit Co., 282 Md. 431, 386 A.2d 749 (1978).
[2] State Highway Admin. v. Transamerica Ins. Co., 278 Md. 690, 367 A.2d 509 (1976); Mayor of Baltimore v. Fidelity & Deposit Co., 282 Md. 431, 386 A.2d 749 (1978).
[3] Sun Insurance Co. of New York v. Diversified Engineers, Inc., 240 F.Supp. 606, 611 (D.Mont. 1965).
[4] See e.g., Phoenix Ins. Co. v. Lester Bros., Inc., 203 Va. 802, 127 S.E.2d 432 (1962); Baltimore v. Fidelity & Deposit Co., 282 Md. 431, 386 A.2d 749 (1978).
[5] However, a bond obligee does have the right to seek payment from a performance bond surety if a bond principal fails to pay subcontractors and suppliers. Mai Steel Service, Inc. v. Blake Constr. Co., 981 F.2d 414, 421 (9th Cir. Cal. 1992). A bond principal does not perform its contractual obligations for purposes of a performance bond until it pays for all the labor and materials used in completing its work. A failure to pay a supplier constitutes a breach of the contract. Glens Falls Indem. Co. v. United States ex rel. Westinghouse Elec. Supply Co., 229 F.2d 370, 375 (9th Cir. 1955).