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Payment Bonds

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$500,000 and less

What are Payment Bonds?

Payment Bonds are a type of Contract Surety Bond often required for construction contracts. 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.

How Do Payment Bonds Work?

This graphic shows how payment bonds work. A construction crane image in the background.

The contractor needing the bond is the principal. The principal pays a third-party surety bond company for a financial guarantee. In exchange for payment and the agreement to indemnify the surety bond company, the surety provides a payment bond to a project owner, or upstream contractor known as the obligee. The payment bond guarantees that the principal contractor will pay certain subcontractors and material suppliers under the contract. This benefits the obligee by keeping the project free of mechanic's liens.

Should the contractor not pay a subcontractor or supplier, they can file a claim against the payment bond. The surety will investigate the claim and pay the claim if necessary. The surety can then go back and seek reimbursement from the principal under the indemnity agreement.

The payment bond provides valuable protection to the owner, suppliers and subcontractors because collecting from a surety bond company may be faster and easier than trying to collect from the principal contractor. This is especially true if the principal is having financial trouble and may be unable to pay their bills.

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 cannot 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.

The Miller Act

What Is the Required Amount of a Payment Bond?

It is standard for a Payment Bond to be written for 100% of the contract amount. In other words, if the underlying contract is $1,000,000 the Payment Bond is usually also $1,000,000. It would be unusual and a potential red flag to have a Payment Bond for any other amount.

Owners and contractors will sometime request payment bonds to be less than 100% of the contract to save money. However, most surety bond companies will charge on the full contract amount, regardless of the requirement. That is because their risk of claim for non-payment remains the same.

Payment Bonds Are Normally Written with Other 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 Obtain a Payment Bond

Payment Bonds are easily obtainable for most contractors. For simple projects of $500,000 or less in value, a simple credit check is all that is needed. Click here or the button and purchase a payment bond in minutes.

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. These stand for Character, Capacity and Credit.

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

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.

The payment bond is intended to protect all persons supplying material and labor for the bonded contract. However, that is 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.

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 the contract. Since they are the contracting party, they bear the risk of non-payment.

This chart shows three parties not covered by a payment bond. Construction blueprints in the background.

What Does a Payment Bond Cover?

This shows 8 common items covered by a Payment Bond. The background is a construction site.

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.

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.

Payment Bond Costs

Payment Bond Issues and Limitations

Although payment bonds are great tool for protecting subcontractors and material suppliers, they do have some limitations. Generally, a claimant under a payment bond must meet certain time, and contract requirements.

Federal Projects

Timing is important to making a payment bond claim on a Miller Act project. First Tier Subcontractors and Suppliers that have a direct contract with the Prime Contractor must wait at least 90 days after they last supplied labor or material to the project before they can file a claim against the payment bond on the project 40 U.S.C. § 3133(b)(2). This should allow enough time for money to flow down to the subcontractor or supplier on the project.

This is different for Second Tier subcontractors and material suppliers. Second Tier subcontractors and suppliers must file a claim within 90 days of the last labor or material provided on the project. This is so the prime contractor can quickly discover if lower tiers have not been paid and hold funds on the project.

Private Projects

Private Projects can also have payment bond issues that contractors should be aware. Generally, in order to have protection under a payment bond, the subcontractor or material supplier must comply with the conditions of the contract. This can be problematic in states that allow Contingent Payment Clauses in contracts. The wording of these clauses is usually, “Pay-If-Paid” or “Pay-When-Paid.

In states where “Pay-If-Paid language is legal, a payment bond may not provide complete protection against non-payment. Because the contract calls for payment to subcontractors and suppliers only if the prime contractor is paid, non-payment to the prime could results in other parties not being paid, even when a payment bond is in place. Contractor operating in these states should be extra cautious.

Payment Bonds Versus Performance Bonds

While Payment Bonds and Performance Bonds are usually written together, they guarantee two very different things. Payment bonds only guarantee that certain subcontractors and suppliers will be paid on a project. On the other hand, Performance Bonds guarantee that a project will be completed according to the contract and at the contract price.

Both payment bonds and performance bonds are normally written for 100% of the contract amount. Because there is only one charge when both bonds are written together, an obligee actually get 200% of the contract amount in protection.

For example, if an obligee requires a 100% performance bond and 100% payment bond on a $1,000,000 project, the principal is only charged once. However, the obligee gets $1,000,000 of protection against claims for non-payment and another $1,000,000 of protection for claims against cost overruns and performance issues.

This chart compares performance bonds to payment bonds. Construction cranes in the background.

Payment Bond Forms

There are many payment bond forms that can be used. Many states have their own statutory form as well as the Federal Government. There are also many standard forms such as AIA, Consensus Docs, EJCDC. Surety bond companies often have their own proprietary payment bond forms and some contractors do as well. It is important to read the requirements of each payment bond form, especially on private contracts.

Summary

Payment Bonds are a valuable tool for protecting contractor and supplier payment rights. Non-payment is a major risk and can cause major turmoil or even business failure. Contact Axcess Surety today to secure a payment bond or for any other surety bond needs.