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A performance and payment bond is a type of surety bond commonly required on construction projects to protect project owners and ensure contractual obligations are met. It combines two key guarantees into a single instrument.
The performance portion of the bond guarantees that the contractor will complete the project in accordance with the contract terms, plans, and specifications. If the contractor defaults, the surety company may step in to complete the project or cover the cost of completion.
The payment portion of the bond ensures that the contractor will pay all subcontractors, laborers, and material suppliers involved in the project. This is critical because unpaid parties may otherwise file a mechanics lien against the property.
If a mechanics lien is filed due to nonpayment, the contractor (or owner, depending on the structure of the project) can obtain a discharge lien bond—also known as a lien release bond—to remove the lien from the property. This bond transfers the lien from the real property to the bond itself, allowing the project to continue without title complications.
When a discharge lien bond is issued, it is typically underwritten by the same surety that provided the original performance and payment bond. However, it is considered a separate obligation and requires an additional bond premium. Even though it is a separate bond, it is usually supported by the same indemnity agreement that was signed when the original bond was issued.
An indemnity agreement is a legally binding contract in which the contractor and any indemnitors (such as owners or affiliated entities) agree to reimburse the surety for any losses, claims, or expenses incurred under the bond. This includes legal fees, settlements, and judgments.
Before issuing a discharge lien bond, many surety companies will request updated financial information and documentation. This often includes current financial statements, details of the dispute, recent payment requisitions, copies of the contract, and any relevant change orders. This allows the surety to evaluate the risk associated with bonding over the lien.
Many contractors are unfamiliar with how discharge lien bonds function after issuance. In most jurisdictions, once a lien is bonded off, the lien claimant (the party who filed the lien) must initiate a lawsuit to enforce or “foreclose” on the lien. Because the lien now attaches to the bond instead of the property, the surety is typically named as a defendant in that lawsuit.
This creates an important legal and financial dynamic. The contractor who obtained the bond (referred to as the bond principal) is obligated under the indemnity agreement to defend and indemnify the surety. As a result, the contractor must retain legal counsel to handle the claim.
In many cases, the contractor’s attorney will be required to represent both the contractor and the surety through a joint defense arrangement. This approach helps avoid duplicative legal costs that would arise if separate counsel were retained for each party. Without a joint defense, the contractor could be responsible for paying two sets of attorneys’ fees, which can significantly increase the overall cost of the dispute.
If the surety ultimately pays out on the claim—whether through settlement or judgment—the indemnity agreement requires the contractor and indemnitors to reimburse the surety for all amounts paid, along with any associated costs and expenses.
Understanding how performance bonds, payment bonds, and discharge lien bonds interact is critical for contractors, developers, and project owners. These instruments not only protect the project but also carry significant financial and legal responsibilities that can impact all parties involved.
Give me a call (212-227-7277) or send me an email (Neil@courtbondnow.com) to discuss your bonding situation.
Neil Pedersen
PEDERSEN & SONS SURETY BOND AGENCY, INC.
305 Broadway, Suite 601
New York, NY 10007
212-227-7277
neil@courtbondnow.com
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