What is a Payment Bond?
Payment bond definition: A payment bond is a surety bond issued to contractors that guarantees that the contractor will pay their subcontractors, material suppliers, and laborers in a timely fashion.
Payment bonds are usually obtained by contractors or subcontractors prior to the commencement of a construction project. Their function is to guarantee that the labor and materials provided by subcontractors and suppliers to a general contractor will be paid for in due time and in compliance with the contract. These bonds also guarantee that payments for labor and material will comply with state and federal laws and regulations.
Payment bonds serve as protection for subcontractors, and offer them legal recourse against contractors who do not fulfill their side of the contract terms. If a contractor has failed to pay subcontractors, suppliers and laborers can file a claim against the payment bond within a certain period of time, and receive compensation by the surety.
In other words, payment bonds are an agreement between the obligee requesting the bond (the subcontractor, supplier or laborer), the principal who obtains the bond (the contractor) and the surety bond company underwriting the bond.
Once a claim is initiated, the surety investigates, in order to decide whether any action must be taken. If the claim is legitimate, obligees can expect to be compensated for their losses up to the full amount of the payment surety bond.
If such compensations are made, principals– i.e. contractors– must compensate the surety for its coverage of the payment bond claim. That’s why contractors should always strive to avoid claims, and seek solutions to problems before they escalate.
Questions about Payment Bonds
Payment bonds are required of contractors in all states, most often for federal and state construction projects.
The requirement to obtain a payment bond for federal projects is regulated by the Miller Act, which requires all contractors who work on a federal project in the amount of $100,000 or more to obtain both a payment and performance bond.
The payment bond protects the subcontractors, material suppliers and laborers of a contractor. Under the Miller Act, this also includes second-tier subcontractors, suppliers, and laborers who work with a first-tier subcontractor.
Payment bonds are also necessary on most state projects. The requirement to obtain a bond on a state project is typically regulated by the so called ‘Little Miller Acts’, which are the state-level equivalent of the federal Miller Act.
Many private construction projects also require contractors to be bonded. On such projects, the scope of a payment bond’s protection is specified in the contract and bonding agreement and depends on the particular case.
Before obtaining such a bond, though, contractors must also be licensed, and bonded with a contractor license bond in their state of operation so as to be legally allowed to perform work as a contractor.
What’s the connection between payment and performance bonds?
Payment bonds, along with performance and bid bonds, are often issued together. Before entering the bid, you typically acquire a bid bond. If you win the bid, you have to obtain a performance bond and a payment bond before work on the project can commence, especially for federal construction projects.
These three bonds are generally issued by the same surety bond company. This is done as a security measure. If a surety wouldn’t underwrite a contractor’s payment or performance bond because it deems the contractor unreliable, it won’t issue a bid bond either (which is usually less costly and risky to issue).
All of this further protects the obligees and guarantees the surety’s backing.
Is it possible to only get a payment bond?
It is usually not possible to obtain this bond without other supporting bonds. However, in rare cases, certain private construction projects may require you to only obtain a payment bond.
But if you’re working on a federal or state project and are required to obtain this bond, you will almost certainly be asked to obtain other contract bonds.
Payment bond cost
Payment bond cost depends on the conditions of the contract you want to obtain a bond for. It is a percentage of the amount of the contract, which you have been awarded during a bid.
Your surety bond cost is a fraction of the total bond amount. This is called your premium.
When determining your payment bond rate, the surety will look at your financial standing. Your personal credit score is of great importance, because sureties use it as an indicator and predictor of financial stability. If you have a high credit score, you will be offered a payment bond at 1%-4% of the total bond amount.
If the contract you have won is worth $250,000 or more, the surety will look at your business even more closely. You will mostly likely be asked to submit personal and business financial records and further documentation about your business, your industry experience and more. Applying for such a bond usually takes slightly longer, due to the more extensive check performed by the surety.
Can you get a bad credit payment bond?
Unlike with most other bonds, we do not offer specific bad credit programs for payment bonds. If you have a slightly lower credit score, you may still qualify for a payment bond.
If you work with a professional construction CPA and your financial records are accurate, you are more likely to obtain a bond, even if you have some mild credit issues. To find out more how you can get a payment bond in such a situation, just call us at (877)-514-5146 and we will work with you to find a solution.
How do payment bond claims work?
If the potential for a payment bond claim arises, avoiding it should be a contractor’s number one priority. If you are experiencing difficulties paying your subcontractors, you should contact your surety and work together with them to resolve the situation as soon as possible. Many claims, if not most, are actually avoided this way.
In order to file a claim, subcontractors, suppliers and laborers must follow a number of procedures so that their claim is accepted. Before filing a payment bond claim, they must file a preliminary notice of a claim, within a period of time after the completion of their work. If a preliminary notice is not filed, the claim may not be accepted later on.
According to the Miller Act, first-tier claimants must not file a preliminary notice on a federal construction project. Second-tier claimants must file a notice within 90 days after the last piece of work.
On state and public projects, state regulations define the period within which a preliminary notice is to be filed, along with any other requirements for payment bond claims.
On private projects, these requirements are usually specified in the contract made between the owner and the contractor as well as in the payment bond. State requirements remain valid for private projects.
If the subcontractors have taken all necessary and timely measures when filing their claim, the surety then steps in to consider the claim and decide whether its obligations have matured. If the surety finds that the claim is legitimate and reasonable, it must compensate all subcontractors, suppliers and laborers who have been harmed by the general contractor.
Once the surety compensates them, the contractor must then pay back the surety for any compensation given to claimants.
Working with the right surety is especially important in times of crisis. A good surety can help you resolve issues before they turn into claims, and it will be your support in the case of a claim against your payment bond.
All bonds produced by Lance Surety Bonds are issued by A-rated and T-listed surety bond companies, making them some of the best bonds on the market.
Obtaining a bond by these companies means more than just having financial backing. It means that you will receive their expert support and professionalism, which are extremely important when challenges arise.
How to get a payment bond?
To get your payment bond, apply online now through our secure contract bond application tool. Soon after your submit your application, we will contact you with a free bond quote on your payment bond. Depending on the specifics of your case, we may ask you to submit additional information about your contract.
Getting bonded for a smaller amount is relatively fast. For higher payment bond amounts, you may have to wait a bit longer before your bond is underwritten. Don’t hesitate to call us at (877)-514-5146 at any time to find out more about how you can get a payment bond. We have extensive knowledge and experience in underwriting payment bonds and can answer all of your questions. Apply now!