Another type of contract bond is the payment bond. These bonds are required for most construction projects, so many, if not most, contractors have had these bonds. Payment bonds guarantee that subcontractors, laborers, and materials suppliers will be paid, and paid on time. Payment bonds and the surety companies that back them keep projects lien-free and help ensure that all parties are happy.
In the last installment of our contract surety bond series, we discussed the performance bond. The payment bond and performance bond are usually issued together in the construction industry, so they are closely related although they are two different bonds.
Just like other contract bonds, the payment bond is a contract between three parties: the owner, the contractor, and the surety. Payment bonds protect people who work for contractors, including laborers and subcontractors, offering legal recourse when general contractors fail to hold up their end of the bargain. Subcontractors, laborers, and suppliers can file a claim for compensation from the surety against the payment bond if a contractor doesn’t pay as promised.
Why Are Payment Bonds Needed?
Payment bonds are needed by law. The law requires payment bonds on all federally-funded projects of $100,000 or more according to the federal Miller Act. Most states have followed this example and mandated payment bonds through their own “Little Miller Acts” where state-funded projects must have payment bonds. Many private project developers also require payment bonds, as they don’t wish to risk a project being completed, only to have liens on it.
In general, contractors buy their performance and payment bonds in the same package before a construction project starts during the contract negotiation phase. To get the payment bond, contractors must be bonded and licensed—in other words, to legally work, they must have a contractor license bond. For this reason, the presence of the payment bond signals to both clients and subcontractors that a general contractor is going to follow regulations and ethics.
What’s the Difference Between Payment Bonds and Performance Bonds?
Although payment bonds and performance bonds are frequently confounded, make no mistake: they are distinct. A performance bond ensures that the contractor completes the job as specified in the contract and according to the law. In contrast, the payment bond guarantees that people who work on the project will get paid, and that the job will be finished without being vulnerable to labor liens.
In short, performance bonds guarantee the work will be done in line with the contract’s terms, while payment bonds cover payment of materials suppliers and workers.
How Are Payment Bonds and Mechanic’s Liens Different?
Mechanic’s liens and payment bonds are often confused. It’s true that they both can possibly come into play when subcontractors and laborers aren’t paid for a job, but they’re very different in practice.
The mechanic lien is a kind of financial interest placed on property by laborers or others who have not been paid for their work on that property. Unfortunately, whether a worker has been paid or not, they cannot place this kind of lien against public property. Therefore, for projects funded by the government, the payment bond is so important; it is the only recourse many laborers, suppliers, and subcontractors have when they’re not paid for their work.
How Much Do Payment Bonds Cost?
The premium on a payment bond varies in terms of cost, depending on the amount of the bond and the conditions of the contract. The payment bond premium is typically a percentage of the amount of the contract.
When deciding how much premiums should cost, the surety company assesses several factors. The personal credit score of the applicant is most important to this analysis. A payment bond premium at 1-4 percent of the total amount can be expected for applicants with strong credit scores. Not to worry, though, because credit challenges are no bar to receiving a payment bond.
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Payment bonds make it possible for private contractors to work on large public construction projects, and for the government to get big projects done. Every project has a better chance of being finished, with all workers paid. And should something go wrong, taxpayers don’t have to pay for it; instead, surety companies pay for contractors who default on their promises and then seek reimbursement from the responsible parties.
For the best rate on a payment bond that works with your financial situation and the project’s contract, contact Viking Bond Service, Inc. Our professional team has years of experience and provides you with the lowest rate possible and the best options for your bond needs.