What is a Performance Bond?
A performance bond is a type of surety bond that is used primarily in projects that have a defined beginning and end.
One party, known as the Obligor (usually a contractor in a construction based project), gets a guarantee from a third party (the surety) to guarantee their work is done on time, done satisfactorily, and is sufficient to meet the terms of the agreement. The surety guarantees that the Obligor will meet all of their obligations to the Obligee (usually the owner of the project).
What is a Payment Bond?
A payment bond is a bond that guarantees that the Obligor will make payments to all of their material suppliers. The bond also guarantees that the Obligor will pay of their subcontractors.
Owners of property are not able to fully determine the risks involved with their construction contractors. Given the incredible complexity of a modern building project – from financing, legal concerns, marketing and sales, project management, to construction – it’s difficult to manage the entire process, much less eliminate risk.
So, in order to eliminate the risk as much as possible, the owner requires the construction firm (the general contractor) to get a performance bond and payment bond. These bonds eliminate the problems involved with construction delays caused by a default by the general contractor. A payment bond eliminates the risk from having to pay twice for the same work (that is, paying the general contractor who then doesn’t pay the subcontractor; the subcontractor can put a lien of the property, so the owner is forced to pay them; creating a second payment).