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Secrets of Bonding #12: This is NOT a Payment Bond!

Post #11 was about Payment Bonds – how they work and who they help.  Let go one step deeper. We will go over a Payment Bond situation that is presented to our underwriting department at least once a year, so it’s worth mentioning.

The Situation: A Prime Contractor or Subcontractor has a project that includes a major vendor. It could be an electrical contractor buying expensive switchgear from a supplier.  In this example the project is NOT bonded.

The supplier has no prior experience with the contractor so they want their purchase order (PO) covered with a Payment Bond. When you are asked to provide it, you immediately reply “Secrets of Bonding #12 tells me this is NOT a Payment bond!”

Let’s see why not, and how you can help your client.

In a normal contract surety Performance & Payment Bond scenario, the bond makes reference to a contract in which the Principal (bond applicant) is being PAID to do work.  If the principal fails in their obligation, the Surety steps in and is PAID the remainder of the contract funds to complete the obligation.

So, if a bond is written on a PO, which way is the money flowing?  In this instance, the principal (electrical contractor) is PAYING money, not receiving.

If the surety bonds the PO and then has a claim, it could only be for the contractor’s failure to pay the supplier. This bond has a single purpose, to guarantee the principals ability to pay money at a future date.  Therefore it is considered a Financial Guarantee, not a typical Payment Bond. This is a much less desirable obligation for the surety because the money is flowing the opposite direction.  Unlike contract surety, in the event of default there is no money coming in (the remainder of the contract price) to enable the surety to deal with the claim.  In fact, many sureties are reluctant to provide such bonds other than in nominal amounts for well-established clients (i.e. Wage and Welfare bonds).

A possible solution: Remember, this is an unbonded contract.   If there was a P&P bond in place, the purpose of the Payment bond would be to protect vendors such as the switchgear provider.  So one solution could be to issue a P&P bond for the electrical contractor even though none was originally required.  The Performance side of the obligation is not needed; however the Payment Bond would be furnished to the supplier to satisfy their concerns.  It will not name them specifically, but protecting them is clearly the purpose of the instrument.

In this manner you can turn an abnormal situation into a typical P&P bond, the kind underwriters like.  Added benefit: the Payment Bond will be for the entire contract amount – which is for more than the switchgear.  This gives some added comfort to the supplier.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #11: Payment Bonds

You’ve heard of “Performance and Payment.” In this article let’s discuss the Payment part because this obligation affects more people and is the most frequent area of claim for sureties.

The old fashioned name for these is a “Labor and Materialmen’s Payment Bond.”  The name says it all: These bonds guarantee that suppliers of labor and material will receive their proper payment. We know labor and material suppliers want to be paid, but why are these bonds required on public work and other contracts?

Why Obligees Require Payment Bonds

Scenario: A company is building a new office facility and hires a general contractor.  The GC then hires a paving subcontractor to put in the parking lot.  If the paver is not properly paid, they may be entitled to file a Mechanics Lien against the property.  He can’t take back his labor and paving material, so the court allows the lien to be filed to protect his interests until there is a legal resolution.

The problem with liens is that the company may have paid the GC properly. It could be the GCs fault that the paver isn’t paid, yet the company is being penalized.  With the lien in place, the company no longer has a clear title. If they want to sell the property, they may have to pay the paver directly even though they already paid the GC!  The payment bond is a source of financial recovery for the paver so there is no need to file the lien and therefore it protects the interests of the obligee as well.

Who Are Payment Bond Claimants?

As the name says, potential claimants are “suppliers of labor and material.”  Other parties that have a direct interest in the contract are also included.

Let’s use our GC and paver situation as an example.  The GC obtains the Performance and Payment Bond.  The paver is a subcontractor to the GC and would be entitled to make a bond claim. The paver’s asphalt supplier is directly supplying materials and can also make a claim.

If the paver hires a striping contract to mark up the parking lot, they are covered. However the paint supplier to the striping contractor is not, legally they are too far removed from the prime contract.  They are working for the sub-subcontractor and are three steps down.  Here’s the flow:

  1. Owner
  2. GC (Prime contractor with owner)
  3. Paver (Subcontractor)
  4. Striping contractor (Sub-subcontractor)
  5. Paint supplier (supplier to Sub-subcontractor)

Remember that the payment bond does not protect parties that are more than two steps down.

Other key points needed for a valid claim:

  • To be covered, materials must have actually gone into the project, not just be delivered to the site.
  • There is a time limit for after which claims cannot be filed.
  • The form and proof of claim must be correct.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)