There are three types of bonds that afford financial protection in connection with a construction project: payment bonds, performance bonds, and bid bonds. Below is a primer on the differences between these bonds and who is protected by them.
Construction bonds may be required by contract or by statute. Although often issued by an insurance company, these bonds are not insurance. Instead, the surety guarantees to the obligee (the entity to which the bond is issued) that the principal (the party who is supposed to perform) will meet its obligations. Most construction bonds require the principal to sign a guarantee. Thus, if an obligation is not met and the surety is required to pay a claim, the surety generally has the right to seek recovery from the principal.
A payment bond guarantees that the principal will pay its subcontractors and suppliers for labor and materials furnished to the project. It is important to pay attention to the language in a payment bond to determine which entities are covered by the bond. For example, a payment bond may not cover second-tier subcontractors (sub-subcontractors to the principal).
A performance bond guarantees that the principal will complete its work on the project in accordance with the contract documents. If it does not, the surety is generally required to complete the contract for the principal, or may be liable for damages up to the penal sum of the bond.
Bid bonds are usually only required for public projects; and serve as a guarantee to the obligee that the contractor’s bid is accurate and that it will enter into a contract for the amount of its bid, and will obtain the required payment and performance bonds. If the contractor does not do so, the surety is generally liable for the amount the obligee has to pay to the next lowest bidder.
The “Miller Act” requires companies that are contracted by the United States for federal public projects (for the construction, alteration, or repair of any public building for more than $150,000) to obtain payment and performance bonds. The Miller Act affords protection to second-tier subcontractors, but there are written notice requirements and time limitations that must be complied with. All of the states have what are referred to as “Little Miller Acts,” that require public contractors to obtain payment and performance bonds under varying conditions. In New Jersey, for example, a principal on a public project is required to obtain payment and performance bonds that also cover second-tier subcontractors. N.J.S.A. § 2A:44-147; N.J.S.A. § 2A:44-143(a)(1).
The Miller Act and all Little Miller Acts have differing notice requirements, deadlines, and other conditions that must be met. Contractors that are not aware of these requirements and do not follow them risk denial of their claims. Therefore, it is important to look into bonding requirements before commencing work on a particular project, in order to understand the conditions applicable to any future claim.
Additional Source: Common-Law or Statutory Payment Bond: Do You Know What Type of Bond Your Contract Requires?; New Jersey Appellate Division Orders Reformation of Surety Bond Consistent With Terms of its Principal’s Contract