Payment Bonds on a Private Construction Project

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Surety bonds are a very efficient way to shift the risks associated with construction away from project owners. For this reason, both the federal and state governments require that contractors performing on projects over particular dollar amounts get bonded.
But securing a project with a surety bond is not limited to government projects. More often than not, private construction projects also make use of so-called contract or construction bonds to secure financial guarantees. For example, bonds that guarantee payments are a very efficient way of protecting subcontractors, laborers and suppliers and mitigating risks for the project. However, how these bonds work and why they are useful is not always understood.
HOW PAYMENT BONDS WORK
When a surety issues a bond to a contractor, it guarantees to the project owner (the bond obligee) that the bonded contractor will comply with their obligations under the contract. А payment bond in particular guarantees that the contractor will pay subcontractors, laborers and material suppliers in accordance with contract conditions.
These bonds are typically required by projects owners in the contract as a way to transfer risk away from themselves. In other words, in order to protect the project and avoid complications such as a mechanic's lien, owners may require contractors to get bonded and have the surety assume the risk. When a surety issues a construction payment bond it guarantees that if the contractor defaults on their obligations to subcontractors, the surety may cover such payments.
While this does not free contractors from their obligations, it guarantees that project owners will not be held responsible for a general contractor's default. The bond also provides the wronged parties with legal recourse against a contractor when their rights have been violated.
Moreover, project owners or general contractors may also require subcontractors to get bonded, especially on projects where there are several tiers of subcontractors involved. This distributes risk more evenly across contractors and holds all parties accountable for their own obligations.
WHY PAYMENT BONDS ARE IMPORTANT FOR CONSTRUCTION PROJECTS
While payment bonds primarily provide security to project owners and subcontractors, they are in fact beneficial for all sides involved. These bonds:
  • guarantee to owners that a contractor has been vetted and prequalified by a surety and complies with several important criteria such as solid financial standing and credit history, good reputation and the required experience for the project;
  • guarantee to general contractors that their bonded subcontractors have also been vetted in much the same way;
  • provide security to project owners and subcontractors in case of a contractor’s default;
  • guarantee to contractors that if an owner declares them in default, the surety will investigate the situation to verify the claim;
  • protect subcontractors from lack of payments but can also protect general contractors against claims when there are several tiers of subcontractors which are also bonded;
  • increase the likelihood of all contractual obligations being fulfilled by all bonded parties because personal and company indemnity is usually required for the issuance of contract surety bonds;
  • allow contractors to increase their bond capacity over time and win new projects by demonstrating their previous success; and
  • provide contractors with support by the surety in situations which may lead to a default and claim.
Whenever payment bonds (and contract bonds in general) provide some form of security or guarantee to an owner or subcontractor, they also offer benefits and advantages to the contractor getting bonded. Being repeatedly approved for bonds increases a contractor's reputation and makes them increasingly more likely to win more projects.

Written by Vic Lance, President of Lance Surety Bond Associates for Construction Executive

Trenton H. Cotney
Florida Bar Certified Construction Lawyer
Cotney Construction Law, LLP
3110 Cherry Palm Dr., Ste. 290
Tampa, FL 33619
www.cotneycl.com

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