What is the difference between a bid bond, a performance bond and a payment bond?

November 1, 2010

This article courtesy of Joseph Blanner, of Behr, McCarter & Potter

Joseph Blanner

The three primary bonds that are purchased on construction projects are bid bonds, performance bonds and payment bonds. Over the years, I have spoken to contractors and owners and, in many instances, there is confusion about what each bond covers. This brief article will attempt to explain the differences.

Example 1: Bid Bond

ABC School District has put out a Request for Proposals for a new roof on their high school building. Contractors X, Y and Z submit bids to perform the work listed in the RFP. The School District requires each of the contractors to submit a bid bond with their bid. The bid bonds are purchased by the three contractors from sureties. The School District decides to accept Contractor Y’s bid. Contractor Y determines that they have underbid the project and decides not to execute the contract and not to perform the work. In this instance, the School District can make a claim against the bid bond due to Contractor Y’s failure to abide by its bid. Thus, a bid bond is a type of bond (often required on publc construction projects, but not exclusively) designed to protect the owner in the event that the bidder refuses to enter into a contract after the contract is awarded or the bidder withdraws his bid before the award. A bid bond is an indemnity bond, which will be discussed below.

Example 2: Performance Bond

Municipality 123 retains Contractor AB to construct a municipal swimming pool at its recreation center. Contractor AB enters into a written contract and begins performing the work. During the performance of the work, Contractor AB goes out of business leaving the work about 50% finished. Additionally, some of the work that was performed was defective. Contractor AB has provided Municipality 123 with a performance bond. Municipality 123 can assert a claim against Contractor AB’s performance bond for the cost to perform the unfinished work and the cost to correct the defective work. Thus, a performance bond protects the owner from the contractor’s failure to perform in accordance with the terms of the contract. A performance bond does not provide protection against subcontractor or suppliers who have not been paid. A performance bond is also an indemnity bond.

Example 3: Payment Bond

Public Water District QQ has retained Contractor ZZ to install a new water tower. Because the project was over $25,000, Contractor ZZ was required by the Water District to provide a payment bond. Contractor ZZ completed the work, but failed to pay Subcontractor X for its work. Subcontractor X cannot pursue any claim against the Water District. However, Subcontractor X can assert a claim against the payment bond for the amount owed to it for its work on the project. Thus, a payment bond is designed to provide security to subcontractors and materials suppliers to ensure payment for their work, labor and/or materials on the project. A payment bond is also an indemnity bond.

Indemnity Bonds: As set forth above, bid bonds, performance bonds and payment bonds are indemnity bonds. These bonds are not insurance policies. If a covered claim arises against a commmercial general liability policy, the insurer has a contractual obligation to indemnify and defend the insured (i.e. the party obtaining the policy) and cannot seek repayment from the insured for amounts paid out as a result of a covered claim. If a claim arises and is paid out on a bid bond, performance bond or payment bond, the surety (the party issuing the bond) will look to the contractor to indemnify and defend it. So, if a claim is asserted against Contractor XYZ’s performance bond, the surety is going to look to Contractor XYZ to defend the lawsuit and to pay any damages.

Please let me know if you have any questions concerning the foregoing. Additionally, we would recommend that you consult with your attorney regarding any specific scenarios.

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