The contractor industry is responsible for the construction of public construction projects such as infrastructure and roads as well as private projects such as buildings and residences. Public works projects require skilled workers and contractors to ensure project completion based on different contract terms. Thus, performance and payment protection are mandated as part of the contractual obligations.
This requirement comes from the Federal Miller Act in the United States that mandates the use of construction bonds for state projects and construction contracts exceeding $100,000. The common types of construction bonds are payment bond, performance bond, and bid bond. Payment bond consists of financial guarantee, performance bond guarantees quality and timeliness, and bid bond that assures fulfillment of responsibilities in the bidding process. Little miller acts' local enforcement also mandates construction bonds and contract bonds for government projects with lower value. As time progresses, many private project owners realize the advantages of contract bonds, leading to more application of these performance and financial guarantees.
This article focuses on construction payment bonds, including what they are, why you need them, and how to get one.
Construction payment bond is a type of payment surety bond that contractors purchase for payment guarantee to subcontractors and suppliers. In particular, the surety provider vouches for the contractor on the contractor’s ability to complete the payment obligations. In other words, payment bonds ensure that subcontractors and suppliers get paid for their contribution as required by the payment terms. These bonds are usually required by project owners when signing contracts in the bidding process. They are commonly used in construction of public projects, such as highways, bridges, and schools.
The three parties involved in a payment bond are the obligee (the project owner), the principal (the contractor), and the third party (the surety company).
Payment surety bonds serve a few roles:
Any contractor interested in bidding on a public sector construction project is required to have a payment bond. Payment bonds are also required by private sector clients with larger budgets to ensure their investments are protected. The bond protects clients from defaulting contractors by ensuring that all payments are made as required to complete a project.
However, in the private sector, contraction bonds may be bonded off a mechanics lien, which is a legal claim on a home or other property, filed by unpaid contractors or material suppliers. Bonding off a mechanics lien requires a mechanics lien bond that allows general contractors and property owners to remove liens against a property and transfer the liability to the bond. However, to fully resolve the payment delays, the surety provider needs to compensate the unpaid parties and seek reimbursement from the general contractor.
Getting a payment bond is relatively easy. Oftentimes, the payment bond even will be issued on the same application as the performance bond by a surety bond company. Below are the basics steps to getting a payment bond.
Construction payment bonds are required in construction projects, especially for government contracts. Several states also require payment bonds for private construction projects. Before getting a payment bond, determine the bonding requirements for the specific project.
Investigate a bonding agent or a surety broker to find one that offers payment bonds at a reasonable rate. Look for broker companies that are reputable, licensed, and experienced.
Before you can apply for a payment bond, you will need to gather some information, including your business's financial strength, your personal financial strength, current work on hand, bank credit information, and prior bond history.
Once you have gathered the necessary information, you can apply for a payment bond through a bonding company. This process can take several days or even weeks, depending on the bond company’s requirements. The information helps the surety provider decide whether one has bonding capacity for construction payment bonds.
Once your application is approved, you will receive a payment bond. Ensure you read the bond agreement carefully and understand the terms before signing.
It is advisable to start the process of obtaining a payment bond early. A payment bond is required to provide security for the project’s completion and payment responsibility. Hence, you must work with a reputable and licensed bonding company to ensure your bond is valid and will provide the required coverage. Moreover, maintaining good credit and a satisfactory claims history can increase your chances of getting approved for a payment bond. Good credit will be especially important for obtaining a payment bond, because it is a type of contract bond, which is riskier for underwriters and brokers than standard commercial bonds. As such, good credit and a solid financial history will be more essential for qualifying for a payment surety bond.
Going back to Step 2 of getting a payment bond, doing your research to find a good surety broker is an essential step for your bond seeking process.
It's important to choose a reputable and experienced surety broker when obtaining a payment bond. A surety broker should have a thorough understanding of the construction industry and have established relationships with multiple surety companies. They should also be able to provide personalized service, be responsive to inquiries, and provide guidance on the bond application process.
When choosing a bonding agent, consider the following factors:
Like other surety bonds, the price one pays depends on the bond amount—which is the size of the contract—and the premium rate—determined by the contractor's credit and financial history. As always, the price will be the bond amount multiplied by the premium rate. However, the payment bond differs from other contractor bonds because the bond amount will be different depending on the state you reside in and their policies on how much of the total construction contract the bond must cover.
Price you pay = Bond Amount * Premium Rate
The cost of a payment bond varies depending on the type of bond you need, the project's scope, and the size of the bond. Typically, a payment bond costs between 1%-3% of the total contract price, but the bond amount is not always the total contract price.
In most cases, the required bond for a project is determined based on the total contract value. However, for very large projects, requiring the general contractor to obtain a multi-million dollar bond may not be feasible. In such cases, there may be different tiers of bond amounts, which decrease as the project value goes up. For instance, a construction payment bond for a $5 million project may need to cover the entire construction contract amount, while a $50 million project may only require a bond of 50% of the total contract value.
Bid bonds are a type of surety bond required by clients before contractors can submit bids for projects. Bid bonds guarantee that contractors will accept the project and sign the contract if selected. They protect the client from contractors who bid on projects but will not accept the job when awarded the contract.
Performance bonds guarantee that the contractor will complete the project in accordance with the specifications outlined in the contract. They also provide assurance that the work will be done on time and within budget. Performance bonds are usually required for public sector construction projects.
Payment bonds, bid bonds, and performance bonds are all essential in the construction industry. Payment bonds ensure that contractors get paid, bid bonds ensure that contractors will accept the project, and performance bonds ensure that projects are completed on time and within budget. These bonds provide security for all parties involved in the construction process.
Payment bonds are essential in the construction industry to ensure that contractors are paid and laborers get fair treatment. They provide peace of mind and security for contractors and clients alike. If you're a contractor looking to bid on a project, be sure to get a payment bond. Protect yourself, your employees, and your investment. As always, do your research, find reputable surety bond agencies, and get the best rates for your needs. If you need any help with any of these parts, please feel free to contact us.
