Payment bonds are frequently required on construction projects and are usually issued in tandem with performance bonds. Payment bonds are required for every contract with the Federal Government worth over $35,000 and have to be 100% of the contract value.
A payment bond is another word for a surety bond, which is a contract that legally guarantees that a contractor or oblige will be able to fulfill contractual obligations. A Surety is a company that is a legally licensed to write bonds, in the state that the project is to take place by regulatory agencies and the Insurance Department.
A surety bond can be applied to a variety of situations and makes sure that the obligee, or person to whom the principal, or contractor, is obliged, will be protected against any loss should the contractor fail to meet the obligation. Some different kinds of bonds include permit bonds, customs bonds, tax bonds and more.
In building, surety bonds can work as a chain and are also used to protect the contractors. Subcontractors can file a claim if they’re not paid, as can the contractor, while the obligee, or the property owner, can also file if the contractor doesn’t fulfill his building requirements. Should the property owner default on payment, the contractor and his subcontractors can file a claim or issue a lien on the property. If the contractor fails to meet contractual obligations, then the property owner can file a claim as well and potentially be reimbursed.
These contracts include at least three parties:
– The obligee, who is the person or entity who will be the recipient of the obligation.
– The principal, who is the party responsible for executing the obligation.
– The surety, who reassures the job will be done
The way surety bonds work is that the principal will pay an annual fee in exchange for the bank or insurance agency issuing a payment bond to maintain its financial strength. The amount of that premium is determined through the penal sum. Almost every surety bond will have a penal sum, or the maximum amount cap that the surety will be obligated to pay in case the principal defaults. This way the surety can properly gauge the risk involved in issuing the payment bond.
If there is ever a claim against the principal due to his or her inability to fulfill contractual promises, then the surety bond will compensate the obligee, and come out of the principal’s pocket. The principal will then be responsible for the value of the payment made to the obligee as well as any fees for legal services, if they are incurred.
The only way this can be mitigated is if the obligee has a ‘cause of action’ against an outside party. A cause of action is defined as information that justifies a right to property, finances, or enforcement of a right. In this case, the surety bond will take over for the principal and recover any funds paid by the principal. This is done through the
right of subrogation, which transfers any ability to enforce a right from one party to another. In case the payment bond is insolvent, and the principal defaults, then the bond is considered valueless, or nugatory. This is why most payment bonds are issued through insurance agencies, whose funds are usually verified through regulation by the government or through private audits, and in some cases, both.
Payment Bonds in terms of Construction
In real estate, payment bonds tend to be used specifically by contractors to make sure their material suppliers, laborers and other subcontractors are paid. Payment bonds are a way for subcontractors to be protected in case the contractor doesn’t pay them in due time, as well as making sure that the payments are up to code with federal and state law.
Payment bonds are required in every state and most frequently for government-backed projects. These kinds of projects tend to be open to the public upon completion. Payment bonds tend to be obtained before the beginning of a new project. These are sometimes accompanied with performance bonds, which guaranty that the contractor will be able to carry out the work as required within the contract. In some cases maintenance bonds may also be put into place, which assures the property owner that the contractor will be available for a predetermined amount of time for upkeep.
