There are numerous types of construction bonds used in the industry, which can be confusing. The good news is that the majority of bonds used in the construction industry are only two types; payment bonds and performance bonds. On most federal and state projects, general contractors are required to secure both a performance and payment bond; and they are sometimes used on private construction jobs as well. But how do they work, and who are they meant to protect? Let’s get started.
What Is a Payment Bond?
A payment bond is a type of surety bond that is issued to contractors to ensure; that all parties involved in the project are paid. A payment surety bond is a type of bond that guarantees certain employees, subcontractors, and suppliers are protected in the event of nonpayment. These are also known as “construction” and “labor and materials.” These bonds are sometimes referred to as “Miller Act Bonds” in government contracting.
Conditional or unconditional private construction bonds are available. An owner is fully protected from having a lien placed on their property under an unconditional payment surety.
What Is the Purpose of a Payment Bond?
Payment bonds are typically required after winning a bid for a public construction project, similar to performance bonds. Payment bonds are critical for ensuring that subcontractors and suppliers are paid according to the terms of their contracts. This means that if problems arise, the other parties involved in the process will not suffer financial losses.
One of the primary advantages of having a payment bond is that it makes it much more appealing; for subcontractors and suppliers to work with you because they know they will not suffer as a result. When these parties work with unbonded contractors, they accept a significant level of risk; knowing that if problems arise, they may not be compensated for their involvement and may be severely harmed financially.
Payment and Performance Bond
Payment bonds are typically issued concurrently with performance bonds. The payment bonds guarantee that certain people will be paid, whereas performance bonds guarantee; that a project will be completed as agreed, including by the completion date. Furthermore, payment and performance sureties both ensure that applicable laws and regulations are followed.
Subcontractors, sub-subcontractors, laborers, and material suppliers seek recovery under bonds. Professionals such as architects have recourse under the construction payment bond in many cases. Project owners make surety bond claims if the project is not completed completely or at all. Work that is not completed by the agreed-upon deadline usually triggers a “liquidated damages” clause; which requires the contractor to deduct a specified dollar amount per day from the contract price. We only bond with top-tier carriers at NFP.
Payment bonds and performance bonds are similar but not the same thing. They are frequently confused because they are typically purchased together and may both be required after winning a bid. Payment bonds ensure that contractors pay their material suppliers and subcontractors as agreed. Performance bonds provide project owners with a financial guarantee that their contractors will perform according to contract terms.
Payment Bond
A payment bond is a type of surety bond that a contractor purchases to protect the property owner; by guaranteeing payment to all subcontractors and suppliers on the project below them.
If a subcontractor or supplier does not receive payment on a private construction project, they may file a mechanics lien against the property. When a payment bond is present, however, it effectively replaces the property to make a non-payment claim. Instead of securing their interest with the property itself, anyone who is not paid must file a claim with the surety.
This is why payment bonds are typically required on state and federal government projects. Liens cannot be placed on the government’s property. The general contractor is required to purchase a payment bond to ensure that everyone on the job is paid.
A construction payment bond can be thought of as an insurance policy if the contractor is unable or unwilling to pay the other parties on a construction project. The bond represents a “pile of money” against which parties can make payment claims for money earned on the project.
On public construction projects (both federal and state), the prime contractor (the one contracting directly with the public entity) is usually required to obtain a payment bond from an accredited surety company, and the bond itself must be a certain amount.
Performance Bond
A performance bond guarantees that the contractor will fulfill its contractual obligations. It is typically purchased for the benefit of the obligee, the government entity, or the property owner in charge of the project by the prime contractor. If the contractor fails to complete all aspects of the contract, the public entity or property owner may file a claim against the performance bond. The surety company that issued the performance bond may then be required to ensure that the project is completed or to cover the entire face value of the bond.
However, while performance bonds are intended to protect government entities and owners, they can benefit the entire project. While the primary purpose of these bonds is to protect government entities and private owners from contractors who fail to complete their work, by protecting owners and government entities, cash flow issues and work stoppages can be avoided. As a result, the overall project will run more smoothly, which will benefit everyone.
Public entities frequently require contractors to post a performance bond to bid on specific projects. The federal Miller Act requires performance bonds for federal construction projects worth more than $100,000. Some states require performance bonds to be posted for public works projects worth much less than $1 million.
Read Also: RETAINAGE: All You Need To Know About Retainage In Construction
Performance bonds are not required by law for private projects. Despite the lack of a mandate, private owners can still require contractors to post a performance bond on a privately-owned construction project if they so desire.
Payment and performance bonds are essential components of any construction project. A payment bond ensures that all parties involved in a job will be paid once the work is completed, whereas a performance bond ensures that the build goes smoothly from start to finish, ensuring that everyone gets what they need when it comes time for final payments at completion.
Do Payment and Performance Bonds Have an Expiration Date?
A surety bond (performance and payment bonds) is typically a legally binding contract in which one party agrees to indemnify another for losses and damages incurred as a result of a breach of an agreement. Performance bonds, payment bonds, and labor protective device contracts with the Department of Labor are a few examples; each has its own expiration date. For example, you may have a one-year performance bond and two-year side agreements.
What Is the Cost of a Payment and Performance Bond?
A payment and performance bond is also known as a surety bond. A performance bond is typically less than 1% of the contract price; however, it can be more expensive depending on who you are contracting with because there is no way to predict how trustworthy they will turn out in the end—which is why so many people have them! Labor and material bonds may also be required if your contractor fails to keep their end of the bargain.
What Is the Definition of a 100 Payment and Performance Bond?
A type of financial guarantee that, in most cases, provides complete protection for contract completion costs. A contract value can cover not only those expenses but also an additional 100% to pay subcontractors or suppliers who have gone unpaid by the original contractor.
What Is the Definition of a Blanket Performance and Payment Bond?
Is a type of surety that ensures the license holder fulfills their contractual obligations. Although this can be provided in cash, an approved contractor’s bond may provide more security if you work on larger projects or need different types of licensure; therefore, it varies depending on your needs.
When Would You Consider Using Performance Bonds?
The construction industry is a volatile one. Work may be proceeding as planned one day and then be halted the next due to inclement weather or equipment malfunction. A contract bond protects against these risks by ensuring that contractors complete projects on time and according to the agreed-upon specifications to be compensated.
Do I Need a Construction Payment Bond?
If you win a bid for a project that requires a bond, you must secure it prior to the start of the project. A bond is typically required for a prime contractor on a construction project.
According to the Miller Act, these bonds are required of prime contractors on all federal contracts worth $100,000 or more. Contracts with foreign governments are exempt. Almost all state contracts have comparable standards, which are governed by the “Little Miller Act” of each state. The federal Miller Act, on which Little Miller Acts are based, governs the bond requirement, assuring that first- and second-tier subcontractors, suppliers, and workers have recourse for recovery if they are not paid on time.
Many private contracts, particularly building contracts, require the primary contractor to submit payment sureties as well. In the text of the contract, private projects needing sureties will state the scope of protection and bond amount required. Visit our what is a contractor bond page to learn more.
What if I don’t require one?
Even if you are not compelled to provide a bond, it is usually a good idea to do so. They will boost your credibility with both the project owner and subcontractors, attracting higher-quality subcontractors to your project.
Qualifying for any sort of surety is also an excellent indicator of the strength and stability of your organization. Furthermore, working with a surety gives you access to professionals such as accountants, lawyers, and others who may be able to provide you with vital guidance. Finally, as a contractor, the enhanced leverage provided by your bond allows you to submit more tenders, resulting in more contracts and increased revenue.
Mechanic’s Lien vs. Payment Bond
Assuming you are familiar with both words, some builders do not understand the distinction between the two. Because the Mechanic Lien cannot be utilized against public property, the payment bond is generally required in government-funded projects. Some suppliers and subcontractors’ only option or instrument for getting paid for their services and labor is the payment bond. Subcontractor default insurance is now used in conjunction with payment and performance obligations by project owners.
Conclusion
There’s not much you can do about performance payment bonds because they’re generally a contractual requirement; you either work on that contract or you don’t. However, if you choose to work on contracts with performance bonds, you should be familiar with them.
Fortunately, the fundamentals covered in this article are sufficient to get you started. With this foundational knowledge, you’ll be ready to deal with these bonds if and when they appear.
Frequently Asked Questions
What is Advanced Payment Bond?
The purpose of an Advance Payment Bond is to reassure the principle that the payment made will be used by the contractor following the underlying contract.
What is the difference between advance payment bond and performance bond?
While the APG allows the employer to recover an advance payment that has yet to be repaid in the event that the contractor is unable to perform or fulfill her obligations under the underlying contract, the PB allows the employer to recover some amount as part of compensation for the Contractor’s failure to perform.
Do you have to pay monthly on a bond?
Can I pay my bond in monthly installments? If you want to divide your bond premium into monthly payments, you must use a financing or payment plan. Many surety companies provide financing, but the bond must meet the financing requirements in order to qualify.
What is the main reason for advance payment bond?
Why should you get an Advance Payment Bond? The APB facilitates and supports client payments to contractors in advance of work being completed. For the contractor, significant costs are frequently involved, and the advance payment can be critical for their cash flow and ability to complete the project.
