What Is a Performance and Payment Bond in Construction?

A performance and payment bond in construction is a two-part surety guarantee: the performance side promises the project owner the contractor will finish the job as agreed, and the payment side promises subcontractors, laborers, and material suppliers they’ll be paid for their work. Federal law requires both bonds on government construction contracts exceeding $150,000, and most states impose similar requirements on publicly funded projects at their own dollar thresholds.¹

The Two Halves of the Bond

Although the two bonds are almost always issued together, each protects a different group and covers a different risk.

The Performance Bond

The performance bond protects the project owner. If the contractor walks off the job, goes bankrupt, or delivers work that fails to meet the contract specifications, the owner files a claim against this bond. The surety then resolves the situation, typically by financing the original contractor to finish, hiring a replacement, or paying the owner the cost of completion up to the bond’s dollar limit.

The Payment Bond

The payment bond protects the people working under the contractor. Subcontractors, laborers, and material suppliers who aren’t getting paid can file directly against the payment bond to recover what they’re owed. This protection matters most on public projects, because unpaid workers and suppliers cannot file mechanics’ liens against government-owned property the way they can on private jobs.

Who’s on the Hook

A P&P bond involves three parties, not two. The contractor who buys the bond is the principal. The project owner or government agency requiring the bond is the obligee. The bonding company that underwrites and issues the bond is the surety.

Most people hear “bond” and picture insurance. It doesn’t work that way, and the difference is the single most important thing to understand. When an insurer pays a covered loss, it absorbs the cost. When a surety pays a bond claim, it turns around and recovers every dollar from the contractor.

That recovery right comes from a General Agreement of Indemnity, which every contractor signs before a surety will issue a bond. The indemnity agreement typically requires the business owners personally, and often their spouses, to guarantee repayment. Personal assets, not just business assets, are on the line. A contractor who treats bonding as insurance and assumes the surety absorbs losses is in for an expensive surprise.

The Penal Sum

Every bond has a “penal sum,” which is the maximum the surety will pay on claims. It’s the bond’s face value and the ceiling on the surety’s exposure. On federal construction contracts, the Federal Acquisition Regulation sets both the performance bond and the payment bond at 100 percent of the original contract price.² A $2 million contract carries a $2 million bond on each side.

If completion costs or unpaid invoices exceed the penal sum, the surety’s obligation stops at the cap and the owner or unpaid parties have to pursue the contractor directly for anything above it. When change orders raise the contract price, the government can require the bond amount to be increased to match, generally dollar for dollar.²

When These Bonds Are Required

Federal Projects Under the Miller Act

The Miller Act, codified at 40 U.S.C. §§ 3131–3134, requires performance and payment bonds on federal construction contracts.³ The statute sets the threshold at contracts exceeding $100,000, and the Federal Acquisition Regulation implements mandatory P&P bonds for contracts exceeding $150,000. For federal contracts between $35,000 and $150,000, the contracting officer chooses alternative payment protections, such as an irrevocable letter of credit or an escrow arrangement, rather than a full payment bond.¹

State and Local Projects

Nearly every state has its own bonding law, commonly called a “Little Miller Act,” that mirrors the federal requirement for state- and locally funded construction. Thresholds vary widely, ranging from as low as $25,000 to as high as $500,000. Check the applicable state’s bonding statute before bidding on any public work.

Private Projects

No law forces private owners to require P&P bonds. Many do anyway on large or complex builds, because a bond shifts the financial risk of contractor default to the surety. Lenders financing private construction also often require bonds as a condition of the loan.

What a Claim Looks Like

When a contractor fails to perform, the owner notifies the surety and files a claim against the performance bond. The surety investigates. If the default is legitimate, the surety chooses among funding the original contractor to finish, taking over and hiring a replacement, or paying the owner the completion cost up to the penal sum. Which route it takes depends on the project’s status, the remaining scope, and the cheapest path to resolution.

Payment claims run through a separate channel. Unpaid subcontractors and suppliers file directly with the surety, which reviews invoices, contracts, and lien waivers before paying valid claims. Whatever the surety pays, it collects back from the contractor under the indemnity agreement.

Deadlines That Can Kill a Claim

On federal projects, the Miller Act sets strict deadlines that permanently forfeit a claim if missed. The rules depend on the claimant’s relationship to the prime contractor.

First-tier subcontractors and suppliers (those with a direct contract with the prime contractor) don’t need to give advance notice. They can sue on the payment bond once 90 days have passed since their last day of work or material delivery without full payment.⁴
Second-tier subcontractors and suppliers (those who contracted with a subcontractor, not the prime) must send written notice to the prime contractor within 90 days of their last day of work or material delivery. The notice must state the amount owed and name the party they worked for or supplied. Only then can they file suit.⁴

Regardless of tier, every payment bond lawsuit must be filed no later than one year after the claimant’s last day of work or final material delivery.⁴ Miss that deadline and the claim is gone. State Little Miller Acts set their own notice periods and filing deadlines, which often differ from the federal rules.

What P&P Bonds Cost

The premium is expressed as a percentage of the contract amount. Contractors with solid credit, strong financials, and a track record of completed projects typically pay between 1 and 3 percent. On a $1 million contract, that’s roughly $10,000 to $30,000. Contractors with weaker credit, less experience, or thin balance sheets pay toward the higher end or may need to post collateral.

Several factors move the premium:

Larger contracts often draw lower percentage rates because the surety’s fixed underwriting costs spread over a bigger base.
Healthy working capital, low debt, and consistent profitability signal lower risk.
A straightforward road-paving job carries less risk than a specialized bridge retrofit, and the premium reflects that.
Tight deadlines, liquidated damages clauses, or unfavorable payment schedules can push the rate up.

How Contractors Qualify

Sureties evaluate three things before issuing a bond, often called the “three Cs”: capacity (can the contractor handle the project’s size and scope?), capital (does the contractor have the financial strength to back the work?), and character (do they finish jobs and pay their bills?). Underwriting pulls credit history, financial statements, work-in-progress schedules, bank relationships, and references from past owners. For larger contracts, sureties want audited or reviewed financials and personal financial statements from the owners.

Newer or smaller contractors often struggle to qualify for bonds on big projects. The U.S. Small Business Administration runs a Surety Bond Guarantee Program that guarantees a portion of the surety’s risk, making the surety more willing to issue the bond. The program covers contracts up to $9 million for non-federal work, and up to $14 million on federal contracts where a contracting officer certifies the guarantee is necessary.⁵ For a contractor trying to break into bonded government work, that guarantee can be the difference between winning a bid and watching from the sidelines.

1
Acquisition.GOV. FAR 28.102-1 General
2
Acquisition.GOV. FAR 52.228-15 Performance and Payment Bonds-Construction
3
Office of the Law Revision Counsel. 40 US Code 3131 – Bonds of Contractors of Public Buildings or Works
4
Office of the Law Revision Counsel. 40 USC 3133 – Rights of Persons Furnishing Labor or Material
5
U.S. Small Business Administration. Surety Bonds