Construction Bond: Bid Bond, Performance Bond, and Payment Bond Explained

A construction surety bond is a three-party agreement between the contractor (principal), the project owner or obligee, and a surety company. The surety guarantees that the contractor will fulfill a specific obligation — completing the project, paying subcontractors, or standing behind their bid. If the contractor defaults, the surety steps in to satisfy the obligation or compensate the owner, then seeks reimbursement from the contractor.

Bonds are required on virtually all public construction projects above threshold amounts and on many private projects. Understanding the three bond types, how bonding capacity works, and what happens when a bond claim is filed is basic literacy for any GC doing commercial work.

The Three Main Construction Bond Types

1. Bid Bond

A bid bond guarantees that if the contractor is awarded the contract, they will actually sign it and provide the required performance and payment bonds. If the low bidder wins but then refuses to sign (or can't provide the required bonds), the owner can recover the difference between the low bid and the next-lowest bid — up to the bond penalty amount.

Bid bonds serve as a prequalification signal: sureties won't issue bid bonds for contractors they wouldn't back on a performance bond. Submitting a bid bond tells the owner that a surety company has evaluated the contractor and is willing to support them through project completion.

Common amount: 10% of bid price on public projects; varies on private. Most public bid solicitations specify the required percentage in the instructions to bidders.

2. Performance Bond

A performance bond guarantees that the contractor will complete the project according to the contract documents. If the contractor defaults — abandons the project, goes insolvent, or is terminated for cause — the surety has several options:

• • Complete the work — the surety takes over and arranges for project completion, typically by hiring a completion contractor
• • Tender a replacement contractor — the surety procures a new contractor to complete the work
• • Pay the owner — the surety pays the owner the cost to complete up to the bond penalty amount
• • Deny the claim — if the surety determines the owner (not the contractor) caused the default, they may deny the claim

3. Payment Bond

A payment bond guarantees that the GC will pay subcontractors and suppliers. If the GC fails to pay — or goes insolvent — subs and suppliers can file claims against the payment bond to recover their unpaid amounts. This is the bonded project equivalent of a mechanic's lien.

On public projects: payment bonds replace mechanic's liens. Because government-owned property cannot be liened, the Miller Act (federal) and state Little Miller Acts require GCs on public projects above threshold amounts to post payment bonds specifically to protect subcontractors and suppliers who have no lien rights. Subs on public projects must file payment bond claims — not liens — to protect their payment.

Miller Act thresholds: Federal projects over $150,000 require payment and performance bonds. State thresholds vary — most states require bonds on public projects above $25,000–$100,000. Check your state's Little Miller Act for specifics.

Miller Act claim deadline: 90 days from last furnishing of labor or materials (first-tier claimants with no direct contract with GC must also give 90-day notice to GC). Miss this deadline and the claim is barred.

How Bonding Capacity Works

A surety company evaluates a contractor's bonding capacity — the maximum dollar amount of work they'll bond — based on three factors often called the "three C's":

Bonding capacity has two limits: single project limit (maximum bond on any one project) and aggregate limit (total bonded work at any one time across all projects). A GC with a $5M single / $15M aggregate limit cannot add a $4M bonded project if they already have $12M of bonded work in progress — the aggregate limit is exceeded.

Indemnity: The Part Contractors Miss

Before issuing bonds, sureties require the contractor — and typically the contractor's principals personally — to sign a General Indemnity Agreement (GIA). If the surety pays a claim, they have the right to recover that amount from the indemnitors: the company and the individual owners who signed.

This is not theoretical. When a surety steps in to complete a defaulted project or pay sub claims, they pursue the contractor aggressively for reimbursement. Personal indemnity means personal assets — home, savings, investments — are exposed. Bonding is not insurance; it's credit. The surety expects to be made whole.

Subcontractor Bonds

GCs can require performance and payment bonds from subcontractors — and often should on large, complex, or high-risk subcontracts. Subcontractor bonds protect the GC if a sub defaults and leaves the GC exposed to completion costs and payment claims from the sub's suppliers.

Whether to require sub bonds is a risk management decision based on:

• • Sub's financial strength and track record
• • Size of the subcontract relative to the project
• • Criticality of the sub's scope to the overall schedule
• • Whether the GC's own performance bond covers sub default risk