The Complete Guide to Construction Payment Bonds | Handle

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The Complete Guide to Construction Payment Bonds

The Complete Guide to Construction Payment Bonds

May 23, 2019

Working on a public works project or a state-owned property can be a little different than working on a regular private construction project — especially when it comes to securing payment. While the mechanics lien can be the most effective weapon in ensuring payment from delinquent clients, it does not work the same way for public projects.

So if you’re a construction professional working on a public project, the payment bond is your best tool against slow payment or even non-payment from clients.

What is a Payment Bond?

The payment bond is essentially an insurance policy that is secured by the prime contractor, in the event that they are not able to fulfill their payment obligations to the subcontractors, suppliers, and other lower-tier parties.

There are three parties at play when it comes to construction payment bonds:

  • The obligee, the party that requires the bond to be posted, which is typically the state;
  • The principal, the party that needs the bond security, which is typically the prime contractor; and
  • The surety, the party that ensures that the principal can fulfill their obligations, and this is typically an insurance company.

While the deadlines and specific bonding amounts may vary per state, payment bonds are generally required for all prime contractors in all publicly funded construction projects across all states.

Three Key Things To Know About The Payment Bond

1. Payment bonds are the solution to payment issues regarding public works construction projects.

Construction Payment Bonds

Keep in mind that once you sign up for a publicly funded construction project, your course of action must be geared towards posting or claiming a payment bond.

2. Payment bonds must be secured by the prime contractor from an accredited bonding company.

If you’re a contractor looking to post a payment bond, make sure that you are getting one from surety company that is recognized by your state’s regulatory agencies. Otherwise, your payment bond may not be valid.

3. Payment bonds are not exclusive to public projects.

While the mechanics lien is only valid for private construction projects, the payment bond may be used in either type of projects. Large-scale commercial projects usually use the payment bond option, as some states prohibit the filing of a mechanics lien against a property if a payment bond has already been posted on it.

How is a Payment Bond different from a Mechanics Lien?

1. Payment bonds are valid on government projects; mechanics liens are not.  

This is a very important point that not all construction professionals are keen about: the mechanics lien generally only applies to privately funded projects. Unless the state’s lien laws contain specific provisions regarding attaching a lien to a public property, the mechanics lien has no power over government projects.

The simplest explanation to this is because mechanics liens encumber a property, and therefore it allows this property to be auctioned off to settle a debt. Public properties, however, must not be subjected to potential claims of private parties. Filing a lien against a government property is therefore not valid.

2. Payment bonds can be claimed by most parties except for the prime contractor.

The mechanics lien may be filed by all parties that have rendered labor, supplies, and other services to a construction project. Prime contractors are allowed to file a mechanics lien against a property if they do not get paid. However, prime contractors are the ones who post a bond — they are not allowed to claim a payment bond.

Prime contractors are the principal parties in a payment bond, so it is them who secure the bond as required by the state. In the event that the prime contractor is not able to pay their subcontractors and other parties down the contracting chain, the payment bond guarantees that these lower tier parties can still be paid.

3. Payment bond notices are sent to parties that are different from the typical recipients of lien-related notices.

There are also required notices to be served when claiming a payment bond, and these notices are sent to the prime contractor, and also to the surety company and the state entity. Surety companies and federal or state departments that commission a project are generally not in the picture in private construction projects, so they do not need to be served the notices that are related to mechanics liens.

4. Payment bond claims do not necessarily have to be “recorded.”

Payment bond claims do not have to be filed at a county recorder’s office unlike a mechanics lien. Typical state requirements regarding “recording” a payment bond claim include sending a copy of the claim to the prime contractor, the public entity and the surety company using a valid delivery method.

How do Construction Payment Bonds Work?

How do Payment Bonds Work

 

Payment bonds protect subcontractors, sub-suppliers, and other parties down the contracting chain because it secures the intervention of a surety company, in the event that the prime contractor fails to fulfill their obligation. The surety company takes over the payment obligations to parties that are claiming payment.

Even the best-run construction project can suffer from monetary claims, especially when multiple parties are involved and some of these parties do not get paid on time for their services. The payment bond remedies potential payment disputes in public projects, because it protects the relevant parties from being left unpaid after furnishing labor or supplies to the project.

Is a Payment Bond Required for All State-Funded Projects?

The short answer is YES. The Miller Act, a 1935 US law, requires prime contractors to furnish the government a payment bond and a performance bond before a contract of more than $100,000 can be awarded.

Each state has their own rules, also known as Little Miller Acts, regarding these payment bonds. The required bond amounts even vary in each state depending on the contract amount. California, for example, requires a 100% bond amount for all projects worth over $25,000 while Nevada only requires a 50% bond amount for all projects exceeding $100,00.

How to Claim a Payment Bond

how to claim a payment bond

1.  Sending a Preliminary Notice

Preliminary notices also come into play in payment bonds. And just like with mechanics liens, the deadlines and serving requirements to sending a preliminary notice for payment bonds also vary per state.

When required, preliminary notices help preserve your right to claim a payment bond. Note that this notice is filed before a payment dispute arises, and deadlines are typically within a certain period after labor or supplies were first furnished.

California, for example, requires the preliminary notice to be sent within the first 20 days of work, while Iowa requires the notice to be served within the first 30 days. New York and Minnesota, on the other hand, do not require preliminary notices prior to claiming a payment bond.

2. Sending a Notice of Intent

A notice of intent is sent after a payment dispute has occurred but before a bond claim is formally submitted. It is exactly what its name implies: it informs the general contractor, the surety company, and the public entity that you are intending to file a payment bond claim because you have not been duly paid.

Sending a notice of intent is typically not a requirement, but sometimes it may be enough to nudge the prime contractor to pay you. Sometimes the prime contractor may be working on a multi-million project and is therefore dealing with multiple subcontractors and sub-subcontractors. The notice of intent may be enough to get their attention so they can finally pay you.

3. Filing a bond claim

filing a bond claim

Similar to the mechanics lien, the rules regarding claiming a payment bond depend on the state you are in. In general, a bond claim must include the name of the claimant, the name of the hiring party, the amount owed, and a description of the project. States like Texas have more specific rules on which information to include depending on whether a written contract was signed or not prior to the commencement of the project.

The deadlines for filing the bond claim also depend on your location. New York and Minnesota both have a 120-day window after the last day of furnishing labor or supplies, while California has a 15-day window after the notice of completion was recorded, or a 75-day window if no notice of completion was issued.

A bond claim must be sent to the prime contractor and the surety company, and sometimes to the public entity as well, depending on the state requirement. Each state also has their own requirements as to how the claim must be served to these parties. In California, for example, the claims may be sent via registered mail or personnel delivery, but only certified mail with return receipt requested is the allowable delivery method in Texas.

Note that unlike the mechanics lien, payment bond claims do not have to be recorded at a county recorder’s office. As long as bond claims have the necessary information and are sent on time to the correct parties, they are considered valid.

It is imperative that you familiarize yourself with the specific bond claim requirements in the state you are working in.

4. Filing a suit against the bond

In the event that the bond claim is rejected or ignored, you may file a suit against the bond. The deadline for filing suit against a bond is usually — but is not always — within one year after the claimant’s last day of work.

Prior to filing a lawsuit against the bond, it is recommended that you send a notice of intent to the prime contractor informing them that you are intending to file this suit. This notice is not a requirement, but in most cases, intending to initiate a lawsuit can be good enough to get the prime contractor to pay up.

Bond claims are reflected in a prime contractor’s bond history, and they affect the price the contractors have to pay when securing bonds for future projects. It is safe to say that prime contractors would prefer not to deal with bond claims and lawsuits, so sending this notice can definitely get their attention.

4 Common Mistakes in Filing a Bond Claim

1.    Not Getting a Copy of a Payment Bond

Nearly all states have specific laws that allow any project participant to be furnished a copy of the payment bond upon request.

The payment bond shows you the terms of the bond. These terms may all be legal-speak, but they may be relevant to you when issues arise regarding your bond claim. Knowing the terms of the bond and just having them on-hand is a good way to prepare for potential legal disputes that may happen.

The payment bond also shows you the name of the surety company. Knowing the insurance company that is supposed to honor the bond when the contractor fails to pay up is very important. The name of the surety company is usually required in the bond claim, and they are also often one of the required recipients of bond-related notices and the bond claim itself.

The payment bond also gives you all other information that allows you to file the claim on time. Doing research on, say, the name of the surety company may take a while, especially when payment disputes have already intensified.

Having important on hand solves this issue, so it is very important to secure yourself a copy of the bond claim. You can do this by writing to the prime contractor and the surety company asking for a copy of the claim. In some states you may have to provide a notarized affidavit to prove that you are indeed working on the project of interest.

The request may also be included in the preliminary notice that you will hand in, especially in states in which preliminary notices are required.

2.     Not filing a preliminary notice

Some states require a preliminary notice to be sent to certain parties, which are usually the primary contractor, the surety company, and the public entity. Preliminary notices for bonds work the same way as preliminary notices for mechanics liens — they both preserve your right to claim the money you’ve duly earned.

The key thing to note here is that every state has different notice requirements, not only when it comes to who receives the notice but also when it comes to deadlines and how these notices must be delivered.

New York, for example, does not require the submission of preliminary notices. Michigan, on the other hand, requires a preliminary notice to be sent to the prime contractor and the public entity within 30 days after the first day of furnishing service to the project. This notice must also be sent via certified mail or any method as long as the claimant can prove that it has been received by the intended parties.

3.     Not filing the claim on time

Just like with preliminary notices, deadlines for filing the bond claim itself vary per state. Missing the deadline is an unfortunately common mistake that could be easily avoidable by paying keener attention to the required time frames for the state’s bond claims.

On top of missing the deadline, filing a claim with incomplete information and failing to serve them to the required parties may result in the rejection of the bond claim. It is best practice to know the deadlines and serving requirements per state.

4.     Not following up on the bond claim

Once the surety receives your claim and they start investigation, it is highly likely that they would require you, the claimant, to provide further information to help them assess your claim. Sometimes they may ask for documentation, and failing to provide these documents may render your bond claim to be unenforceable.

It is highly advised that you monitor the surety’s progression in assessing your bond claim by following up and asking them about its status. You must be able to accommodate their requests for more information and documents, within reason, in order to strengthen your claim and secure your payment.

When do I file a bond claim vs. a mechanics lien?How is the project funded - payment bond

Deciding whether to file a bond claim or a mechanics lien depends on multiple factors. The most important consideration is obviously about the nature of the project, whether it is publicly funded or privately funded. For publicly funded projects, a bond claim is the only option.

Privately funded projects, on the other hand, may or may not be bonded. Since payment bonds can be posted on both public and private construction projects, a potential claimant must know if a bond has been obtained for the project they are working on.

If a private project has been bonded, the claimant must then find out whether the state allows the filing of a mechanics lien on a bonded property. If not, then bond claims are the way to go. Otherwise, filing a mechanics lien can be an option.

What about for P3 Projects, or public-private partnerships?

This is when it becomes difficult to decide between a bond claim or mechanics lien. The quick answer would be, it depends. P3 projects are best analyzed on an individual basis as there many factors to consider. The nature of a project is a big consideration, just as much as the laws and regulations in the state in which the project is being constructed.

There is no simple answer when it comes to P3 projects. The best advice would be to first secure a copy of the bond claim to know the relevant terms and to look into the state’s laws regarding bonds and mechanics liens.

 

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