Performance bond indemnity agreements sit at the junction of project delivery, risk transfer, and credit. If you build, how to get axcess surety finance, or manage construction or industrial projects, you will eventually sign one, enforce one, or untangle the fallout from one. I have negotiated these agreements from the contractor’s chair and defended claims from the surety’s side. The same few pages of indemnity language can save a project or wreck a balance sheet, depending on how they are understood, documented, and managed over time.
What a performance bond really covers
A performance bond is a surety’s promise that the contractor will complete the project in accordance with the contract. If the contractor defaults, the surety steps in up to the penal sum of the bond, often 100 percent of the contract price, sometimes 50 percent or 200 percent depending on the owner’s requirements and market norms. Public work in the United States typically uses 100 percent performance bonds for contracts above statutory thresholds, while private owners vary.
That definition hides a practical truth: the surety does not price the probability of loss the way an insurer does. A performance bond is not insurance. It is a credit instrument backed by the contractor’s promise to indemnify the surety for any loss, and often secured by personal guarantees of owners, cross-corporate guarantees, and a general agreement of indemnity, or GAI. When a surety pays a claim, it expects to be made whole. The GAI is the mechanism that makes that expectation enforceable.
The general agreement of indemnity: the backbone
Most contractors execute a GAI with their surety before any bond is issued. It stays in force across projects and applies to every performance bond and payment bond the surety writes for that contractor. GAIs look deceptively short. The implications are anything but.
The essential grant reads something like this: the indemnitors agree to exonerate, indemnify, and hold the surety harmless from any loss, cost, or expense arising from the bonds, including attorney fees and consultant costs, as well as amounts paid in settlement or to mitigate loss. Three verbs matter. Exonerate means the indemnitors must keep the surety from ever having to pay. Indemnify requires repayment if the surety does pay. Hold harmless covers the cost of defense and administration.
Many GAIs add additional powers, including the ability to settle claims, to take over contract performance, to demand collateral security on short notice, and to access books and records. Some even include a confession of judgment in certain jurisdictions. If that term makes you uneasy, it should. It allows the surety to enter a judgment for a sum certain without full litigation, and although courts scrutinize these, they can move quickly once defaults hit.
Who signs and why it matters
Bonding capacity depends on capital, character, and capacity. Underwriters look at audited financials, backlogs, management, and past performance. But when paper meets pen, the surety wants a broad pool of indemnitors. The contracting company signs. The owners sign personally. Affiliated companies sign cross-corporate indemnity. Sometimes spouses are asked to sign. The purpose is simple, even if awkward to negotiate: if a claim happens, the surety wants multiple paths to recovery.
Personal indemnity is the pressure point for closely held contractors. Owners often ask whether they can limit it. You can negotiate thresholds, carve-outs for certain assets, or sunset provisions as the company grows, but until a contractor has a strong balance sheet and a track record with meaningful working capital and net worth, personal indemnity is standard. Lenders and sureties align on this point more often than not.
The surety’s rights and the contractor’s obligations
The surety stands in a unique position when trouble emerges on a bonded job. It owes obligations to the obligee under the performance bond. It has contractual rights against the principal and indemnitors under the GAI. And it has equitable rights, such as subrogation to contract funds and lien rights that arise under law. These intersect in messy ways.
When the obligee declares default and makes a bond claim, the surety investigates. If default is clear and undisputed, the surety will pick a remedy under the bond: finance the existing contractor, tender a completion contractor, take over the project, or pay the obligee up to the penal sum and walk away. The GAI allows the surety to take control of contract funds and, in many agreements, to settle claims in good faith without a full defense. That phrase, good faith, carries an immense weight. Courts in many jurisdictions accept a surety’s documented, reasonable decision-making as sufficient, shifting the burden to indemnitors to prove bad faith if they challenge the loss.
On the contractor’s side, the GAI imposes duty to cooperate. That includes furnishing records, assigning contract balances, and providing collateral upon demand. Many principals are caught off guard by the collateral obligation. The clause typically allows the surety, upon receiving a claim or anticipating exposure, to demand immediate collateral equal to the estimated loss. Failure to post collateral can generate a separate cause of action. It sounds harsh because it is. The surety wants to stop bleeding before it starts.
How claims actually unfold
In practice, performance bond claims rarely arrive out of the blue. A job starts to slip. Schedules go red. Subcontractors slow down or walk until they get paid. The owner sends cure notices. The contractor scrambles to staff up or negotiate change orders. Meanwhile, cash tightens as underbillings grow and stored materials pile up. That is when the surety hears rumblings.
Experienced contractors loop in their surety before a formal default. There is often a narrow path to salvage the job: a financing accommodation, a joint check agreement with critical subs, or a short-term infusion of equity. If the surety believes the contractor’s plan has a realistic path and that the owners are willing to support it, financing the principal through completion can cost less than takeover. If trust erodes or the numbers do not pencil out, the surety will prepare for the worst. That is the moment when the GAI’s collateral clause may be invoked.
If default is declared, the surety’s loss control gears engage. Consultants estimate remaining costs to complete, cure defective work, and address delays. The surety evaluates liquidated damages exposure, which can reach tens of thousands per day on large projects. Contract funds are tracked to the penny: earned but unpaid funds, retainage, pending change orders, and potential back charges. If the contract balance suffices to finish the job with a margin, the surety leans toward tender or financing. If not, takeover or settlement becomes more likely.
The shadow of subrogation and contract funds
Surety law gives the surety equitable subrogation rights to contract funds and certain security. Put simply, the surety steps into the contractor’s shoes with respect to money earned on the bonded contract. That includes progress payments and retainage, subject to the owner’s setoff rights and the claims of unpaid subs and suppliers. When a contractor defaults, the surety can assert a right to those funds ahead of general creditors. That priority shapes workouts and bankruptcy outcomes.
I have seen turnarounds hinge on preserve-the-fund tactics. One contractor on a municipal water plant was sliding toward default with $4 million in retainage held by the owner. By negotiating a structured assignment of those funds to the surety, paired with joint checks to critical vendors, we managed to keep the job moving and limit the surety’s cash outlay to $1.2 million. The GAI made the assignment enforceable. Without it, the owner might have set off delay damages and the money would have evaporated.
Negotiating the GAI without losing the deal
Most GAIs are on preprinted forms, but they are not sacred scripture. Points worth attention, depending on leverage and relationship, include:
- Collateral demand triggers and timelines. Narrow “anticipated exposure” to documented claims, set a reasonable period to post collateral, and provide for release when exposure abates. Books-and-records access. Allow access relevant to bonded obligations rather than unfettered corporate-wide fishing expeditions, while acknowledging the surety’s need to evaluate global risk.
Keep expectations realistic. Sureties resist material changes that handicap claim response. Nonetheless, clarity helps both sides. I favor adding a notice and consultation provision around major settlements. It does not handcuff the surety, but it aligns communication when it matters most.
Personal indemnity and the family home question
For closely held firms, the question that keeps spouses awake is whether the family home is at risk. The answer depends on title, state homestead protections, and the scope of personal indemnity. In community property states, even a non-owner spouse may have exposure if community assets are involved. Some GAIs permit carve-outs for specific assets, or allow a spouse to sign solely to waive community property claims without full indemnity. If a surety agrees, document these boundaries precisely. Do not rely on oral understandings.
A practical point: even where exemptions protect a residence from judgment creditors, a surety can still obtain a judgment and create a lien, which may complicate refinancing or sale. Long before a crisis, map your asset structure. Coordinate with your lender, because intercreditor agreements and UCC filings interact with the surety’s rights.
Payment bonds and why they matter to performance exposure
Performance bonds rarely travel alone. Payment bonds secure the obligation to pay subs and suppliers. Nonpayment can trigger performance issues, because unpaid subs walk and schedules collapse. Sureties analyze combined exposure. A contractor with a stubborn dispute over a large change order may find liquidity disrupted, payment claims stack up, and the owner, frustrated by job progress, lobs a default letter. The GAI wraps both payment and performance losses together. If you are managing risk, treat them as a single ecosystem: cash flow, schedule, and claims handling live in the same house.
The owner’s role and default letters that stick
From the owner’s side, default should not be declared lightly. Bond forms require notice and an opportunity to cure, and many contracts require the owner to provide specific warning steps before termination. The difference between a sloppy default and a clean default can be millions. I have seen owners lose bond coverage because they terminated too fast or failed to comply with conditions precedent. If you want the surety to answer, follow the contract. Invite the surety to meetings before the cliff. Provide contemporaneous documentation, not a retrospective pile of grievances.
Owners also face a choice between directing performance and allowing the surety to select a remedy. A heavy-handed owner who dictates means and methods after default may dilute the surety’s responsibility. Good owners make a record, state performance expectations, and then let the surety do its job while monitoring closely.
Estimating the real cost of a performance claim
The headline number is the penal sum of the bond, but the real economics move beneath it. Loss components typically include:
- Completion costs above the remaining contract balance, including premiums for accelerated work and re-mobilization. Professional fees for consultants, engineers, and attorneys, which can run into high six figures on complex jobs.
Even where the surety’s direct payment is modest, fees and internal costs can be substantial. Under most GAIs, these are recoverable from indemnitors. The contractor rarely appreciates that at the front end. During underwriting meetings, I make it explicit with examples: a $750,000 completion cost might carry $150,000 to $300,000 in professional fees if the dispute is contested and involves multiple claims and change issues. That clarity encourages earlier action.
Early warning indicators that matter
You can feel projects that are drifting. The reports may still look fine, but several signs almost always correlate with future bond involvement. Pay close attention if three or more of the following appear together:
- Chronic underbillings growing month over month without a credible catch-up plan. Stretching payables beyond supplier terms while payroll stays current and equipment rentals are late.
These are not academic markers. They show up in board decks right before the surety gets a call. If you see them, bring the surety and lender to the same table. The worst losses happen when the contractor keeps both in the dark and tries to outrun cash with new awards.
Collateral security: how demands play out
A collateral demand is the surety’s fire alarm. The letter arrives, cites the GAI, and requests a stated sum to secure anticipated exposure. The number may feel aggressive, because the surety models downside. Options exist, but the window is short. Indemnitors can post cash, issue an irrevocable letter of credit, or pledge acceptable liquid securities. Real estate is rarely accepted as primary collateral due to liquidity friction.
If you do not have the liquidity, negotiate structure. I have seen sureties accept staged collateral that steps up with milestones, or carveouts as risks resolve. Offers should be specific, not hopeful. Bring completion schedules, subcontractor releases, and owner correspondence to the meeting. The surety’s trust metric rises with verified data. If you promise collateral and fail to deliver, you lose credibility for months.
Common mistakes that turn manageable claims into disasters
Two behaviors create unnecessary damage. First, unilateral settlements. Principals sometimes pay a complaining subcontractor off-book with personal funds to quiet noise. That undermines the surety’s ability to control claims and can violate the GAI’s cooperation clause. Second, document gaps. When change directives fly fast, field teams build before pricing is settled. If the owner later disputes scope, the surety’s completion cost jumps. Train project managers to time-stamp directives, cost them, and secure interim written acknowledgment. A one-page email that confirms scope and price range can save six figures later.
Bankruptcy and the surety’s place in the line
If the contractor files bankruptcy, the GAI does not vanish. The surety’s equitable subrogation rights and any perfected security interests matter. Contract funds tied to bonded projects are often carved out as trust funds or subject to priority claims for labor and material, depending on jurisdiction. The surety will move to obtain relief from stay to exercise contract assignment and takeover rights. Indemnity claims against individual indemnitors continue outside the corporate bankruptcy unless those individuals also file. Plan ahead. Prepetition collateral and clean trust accounting strengthen the surety’s position and can keep a reorganization viable.
Choosing a surety partner and building capacity
Prices for bonds are generally regulated and not the primary differentiator. Relationship, claims philosophy, and bench strength matter more. Some sureties prefer finance-and-finish; others default to takeover. Ask for claim case studies. Meet the claims manager before a crisis. Share quarterly financials proactively, not just at renewal. When your backlogs spike 40 percent after a big award run, invite the surety to your internal risk meeting. I have seen a half-hour session with operations heads prevent a future default when a surety flagged craft shortages that the sales team had not considered.
Practical steps to keep the GAI in its sheath
The best outcome is never needing to test the indemnity provisions. Several habits reduce the chance:
- Keep work-in-process schedules honest. If gross profit fade exceeds 2 to 3 percent over two quarters without clear cause, pause new awards. Align payment terms with supply chain. Do not accept 60-day owner pay when your key suppliers demand 30-day terms unless you carry the float with real cash.
These are discipline moves, not paperwork. Few contractors fail from one big mistake. They bleed from a dozen small ones that the surety sees only after the ulcer forms.
A brief example from the field
A regional heavy civil contractor took on a $22 million bridge replacement with a performance bond. Midway, bad geotechnical data caused unforeseen pile driving issues. The owner issued some directives but delayed formal change orders. Underbillings climbed to $3.1 million. Subs tightened. Payroll stayed current, rentals slipped. The owner’s project manager threatened default.
We pulled the surety in with a frank presentation: photos, engineer memos, a delta estimate, and a 10-week recovery plan. The surety agreed to a $1.5 million working capital facility secured by contract funds, contingent on three conditions: joint checks to the piling subcontractor and steel fabricator, weekly progress meetings with minutes, and an executed interim change directive acknowledging entitlement, even if pricing remained open. The owner agreed because they wanted the bridge open before winter. The job finished 12 weeks late, liquidated damages were negotiated down to $280,000, and the surety’s net outlay was recovered from contract balances plus a modest contribution from the indemnitors. Without early engagement, that same job would have gone to takeover with a seven-figure loss.
Final thoughts from the trenches
Performance bond indemnity agreements look like boilerplate until they are not. If you run a contracting business, treat the GAI as a living part of your risk architecture. Keep a clean file with the signed GAI, any riders or carve-outs, and a current list of indemnitors. Revisit it annually when ownership changes or a spouse enters or exits. Educate your project teams on the real triggers: cure letters, payment claims, and schedule slippage that cannot be recovered by the next update. If you are an owner, follow the contract steps for default with precision and keep the surety informed early.
At its best, the triad of owner, contractor, and surety works like a stabilizer. Everyone wants the same outcome, a completed project, fair payment, and minimal delay. The GAI gives the surety the tools to intervene when needed and to be repaid when it does. Use that framework with clear eyes. When you respect what the indemnity means on paper, you reduce the chance that it becomes the most expensive document in your file.