The performance and payment bonds are intended to protect the owner of the construction project against contractor failure and to protect certain laborers, material suppliers, and subcontractors against nonpayment by the contractor. The term is also used to denote “a collateral deposit of good faith money, intended to secure a futures contract, commonly known as margin.”
The federal government introduced performance and payment bonds to fix the high failure rate among the private firms in performing public construction projects. The projects awarded to private contractors were left unfinished due to contractors’ insolvency and the taxpayers were forced to cover the additional costs arising from the contractor’s default. The laborers and material suppliers also suffered hardships due to the default by private contractors since government property was not subject to mechanic’s liens. The government tried using individuals to serve as sureties, but many of those sureties were not able to indemnify the affected group for want of financial resources. Hence, as a remedial measure, Congress passed the Heard Act in 1894 to authorize the use of corporate surety bonds to secure federal construction contracts performed by private parties. In 1935, the Heard Act was replaced by the Miller Act, which is the current law requiring performance and payment bond on federal construction projects.
The Performance Bond secures the contractor’s promise to perform the contractual obligations at the agreed upon price, and within the time allowed. The Payment Bond protects the laborers, material suppliers and subcontractors against nonpayment by the contractor.
Performance bonds are mostly used in the construction and development of real property and large scale civil construction projects. The owner may require the developer to assure that contractors procure performance and payment bonds in order to guarantee that the value of the work will not be lost in the event of insolvency of the contractor or any other unforeseen event.