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Payment Bonds

What are Payment Bonds?

Payment Bonds are a type of Contract Bond. Payment Bonds guarantee that subcontractors and suppliers will be paid and that the project will be free of mechanics liens.
Payment bonds are a three party agreement. The Principal is the party is responsible for completing the contract. This is usually a Contractor. The party that is receiving the benefit of the Payment Bond is referred to as the Obligee. This is usually The project owner or upstream contractor. The Surety is the third party that is guaranteeing that the Principal pays its bills. This is the bond company.

Why Am I Being Asked For a Payment Bond?

Payment Bonds are required on Federal Projects of $150,000 and above. This requirement is part of The Miller Act. The reason is to protect subcontractors and suppliers on Federal work because mechanics liens can not be placed on Federal property. Many states and municipalities have adopted similar requirements, often called Little Miller Acts.
Owners and lenders on private projects may also require Payment Bonds as a means of ensuring that a project is completed on budget with no liens placed against the project. General Contractors and other contractors may also require Payment Bonds from subcontractors as a way to manage payment risk on their construction projects.

Amount of Payment Bonds

It is standard for a Payment Bond to be written for 100% of the contract amount. In other words, if the underlying contract is $1 million, the Payment Bond is usually also $1 million. It would be unusual and a potential red flag to have a Payment Bond for any other amount.

Written With other Contract Bonds

Payment Bonds are often written together with other Contract Surety Bonds such as Performance Bonds, Bid Bonds, and Maintenance Bonds. Although a Payment Bond can be required by itself, most surety bond companies do not charge a separate premium to write it together with a matching Performance Bond. Therefore, there is no reason for an Obligee to not require both on a given project.

How to Get a Payment Bond

Payment Bonds are easily obtainable for most contractors. For simple projects of $1,000,000 or less in value, a simple credit check is all that is needed. Click here or the button below and purchase a Payment bond in minutes.
Payment Bond Instant Purchase - Green button with a white key to purchase a payment bond instantly
For larger projects, more information may be required such as business and personal financial statements. A surety bond company will also likely run a credit report on the business. Since a Payment Bond guarantees that a Principal will pay their bills, it's important to have a solid track record of doing so in the past. Payment Bonds are a type of Contract Surety Bond. These bonds are underwritten using the 3Cs which you can learn more about here.

Which Subcontractors and Suppliers Are a Protected by a Payment Bonds?

The payment bond is intended to protect all persons supplying material and labor for the bonded contract. However, that is not not completely accurate. Subcontractors and Material Suppliers with rights under a standard payment bond include:
  • First-Tier Subcontractors – This includes all subcontractors that have a contract directly with the Principal.
  • Second -Tier Subcontractors – All subcontractors who have a contract with the First-Tier Subcontractors.
  • First-Tier Material Supplier – All material suppliers who contracted directly with the Principal.
  • Some Second-Tier Material Supplies – All material suppliers who contracted directly with a First-Tier Subcontractor.

 

 

Parties Protected By a Payment Bond - This chart shows the subcontractors and suppliers that are and are not protected by a payment bond. The background is a building under construction with a contractor holding a money bag.

 

Other potential claimants under a payment bond include those providing professional services to the project including Engineers, Architects and Surveyors.

Who Is Not Covered by a Payment Bond?

  • Third-Tier Subcontractors – All subcontractors who contract with a Second Tier Subcontractor
  • Some Second Tier Material Suppliers – All material suppliers who supplied a First-Tier Material Supplier
  • The Prime Contractor – The prime contractor does not have a claim for non-payment. Instead, they must file a suit against the Owner or Government for non payment under thw contract. Since they are the contracting party, they bear the risk of non payment.

What Does a Payment Bond Cover?

In addition to labor on a covered project, material provided on the project is protected.  Courts have ruled that under The Miller Act, the supplier only needs to demonstrate that it is, “reasonably believed” that materials were to be used in the project to have protection under the payment bond. Therefore, the items that could be covered are almost endless. Some examples of the items that have been covered under payment bonds in case law include:
  • Rental Equipment
  • Fuel, oil, tires and repairs which were used in equipment for the project
  • Tools used for the project
  • Taxes for the project
  • Delay costs
  • Many others

Indemnity is Required

Payment Bonds are written on the Principle of Indemnity. That means that if a loss occurs, the surety bond company will look to the company, and/or other indemnified to reimburse them for a loss. Payment Bonds are not insurance and more closely resemble a credit product. You can read more about surety bond indemnity here. Payment Bond claims often precede performance Bond claims and could be a sign of cash flow issues to a surety bond underwriter.

Payment Bond Costs

Payment Bond costs are based on the financial strength and capabilities of the Principal. In general a range is somewhere between 0.3% - 3%. Usually Payment Bond rates are on a sliding scale meaning the rate decreases as the project gets larger. However, flat rates are not uncommon. Other factors may also increase the rate such as design-build projects, extended maintenance periods or long project durations. It is important to note that if a Performance Bond is written with a Payment Bond, there is only one charge and not a charge for each bond separately. You can read more details about Payment Bonds Costs and how contractors can reduce those rates here.