Payment Bonds

A payment bond is a type of contract surety bond. It’s a 3-way guarantee between a Contractor (Principal), Owner or Higher Tier Contractor (Obligee) and a Surety (Bond Company). Payment bonds guarantee that suppliers and subcontractors will be paid. If they are not, they can file a claim against the payment bond. The payment bond is meant to protect both public and private work from mechanic’s liens. Typically, payment bonds are issued together with performance bonds but some Obligees will ask for a payment bond only.

Who Needs Payment Bonds?

The Miller Act requires payment bonds equal to 100% of the contract amount to be issued on all Federal construction projects over $150,000. Most states and municipalities have adopted “Little Miller Acts” that require payment bonds on state and local projects as well. Because liens cannot be placed on public work, the payment bond in combination with the performance bond provide a means for protecting the project from mechanics liens of subcontractors and suppliers.

Additionally, private owners may require payment bonds on their projects to keep them lien free as well. Also, Contractors may require performance bonds and payment bonds from their subcontractors to ensure that the work gets completed and their subcontractors and suppliers get paid.

Who Is Covered by a Payment Bond?

The payment bond is intended to protect all persons supplying material and labor for the bonded contract but, that is not the case. Those with right under a standard payment bond include:

• First-Tier Subcontractors – This includes all subcontractors that have a contract directly with the Principal.

• Second -Tier Subcontractors – All subcontractors who have a contract with the First-Tier Subcontractors.

• First-Tier Material Supplier – All material suppliers who contracted directly with the Principal.

• Some Second-Tier Material Supplies – All material suppliers who contracted directly with a First-Tier Subcontractor

Other potential claimants under a payment bond include those providing professional services to the project including Engineers, Architects and Surveyors.

Who Is Not Covered by a Payment Bond?

• Third-Tier Subcontractors – All subcontractors who contract with a Second Tier Subcontractor

• Some Second Tier Material Suppliers – All material suppliers who supplied a First-Tier Material Supplier

• The Prime Contractor – The prem contractor does not have a claim for non-payment. Instead, they must file a suit against the Owner or Government

What is Covered by a Payment Bond?

The items that can be covered by a payment bond are virtually endless. Courts have ruled that under The Miller Act, the supplier only needs to demonstrate that it is, “reasonably believed” that materials were to be used in the project to have protection under the payment bond. In additional to labor and material, some of the items that have been covered under payment bonds include:

• Rental Equipment

• Fuel, oil, tires and repairs which were used in equipment for the project

• Tools used for the project

• Taxes for the project

• Delay costs

• Many others

How Do I Get a Payment Bond?

Companies with good credit can get payment bonds up to $500,000 freely with a simple application. Larger bonds may require additional information and our staff are happy to help you through the process. The chart below shows how to get a payment bond:

Although each payment bond is different, the below table shows what scope of financial information is needed for different projects.

The better the quality the financial statement, the better rate the contractor will qualify for. In many circumstances, the better bond rate more than offsets the additional cost of the CPA. For contractors who need more than 1 or 2  construction bonds per year, a CPA prepared statement will more than pay for itself. In addition to the Corporate financial statements, usually the following will be required on larger projects:

• A personal financial statement on any owner owning more than 15% of the stock

• A completed application

• A copy of the contract to be bonded (A payment bond follows the contract so the surety bond company will want a copy of the contract before issuing the payment bond.)

Contractors can learn more about the underwriting process for getting payment bonds and other construction bonds by watching this video. Also, you can view our case study on getting performance and payment bonds here.

What If I Have Bad Credit?

At some point, many great companies and owners have had setbacks. Not to worry. MG Surety Bond works with all major bond companies as well as specialty bond companies. Credit is an important piece of the underwriting process but not the only piece. We will work with you and the company to find a solution everyone is comfortable with. In rare circumstances, we have other tools that can help contractors with credit challenges including access to the SBA Bond Guarantee Program, Funds Control and Collateral Programs. There is rarely a situation when we cannot provide a solution. Unlike some internet companies, we are surety bond experts first. It is one of the reasons we have been so successful. Contractors often find us after they have been turned down by another company.

What Does a Payment Bond Cost?

First, if a performance bond is required, the payment bond is included in that cost. In other words, you do not have to pay for two separate bonds. There are instances when only a payment bond is required though. The cost of the payment bond is based on the contract price, scope of work and strength of the contractor. Typically, this ranges anywhere from 0.5%-4%. Often the payment bond rate is on a sliding scale so that the percentage get smaller as the job get bigger. For example, a standard sliding rate for a General Contractor performing “Class B” work would be as follows:

In the example above, a $1,000,000 would cost $13,500 or 1.35%. The calculation is as follows:

($100,000/$1,000) x $25 = $2,500

($400,000/$1,000) x $15 = $6,000

($500,000/$1,000) x $10 = $5,000

      $13,500

You can read all about Payment Bond rates and how to reduce them here.

Time Requirement for Payment Bond Claims

Proper notification is essential to filing payment bond claims. Each state and municipality have their own regulations and filing requirements. Subcontractors and Suppliers would be wise to know the local requirements for each project they are working on. Additionally, on private work, a General Contractor may have their own payment bond form with different filing requirements, so these should be read carefully. In general, payment bond claim should be filed within 90 days from the last time material and labor was furnished on a project. For any Subcontractor or Material Supplier not directly contracted with the Prime Contractor, this is a requirement and failure to meet this timeline will invalidate your payment bond claim. Even for those that have a direct contract, this is a best practice. One of the biggest mistakes I see is that contractors believe they will get paid and fail to file their claim notice in time. Always file a timely notice. The Prime Contractor can still pay after you after a payment bond claim is filed and the added pressure from their Surety Bond Company will likely speed up your payment.

Payment Bond Claim Filing Requirements

On Miller Act Claims, the claim notice must be sent to the Prime Contractor (Principal) and must be delivered by a means that provides written, third party verification. Although not required, a best practice would also be to send a claim to the Surety Bond Company who wrote the payment bond and the Owner or Government Contracting Officer. The claim notice should include the amount claimed and the name of the party to whom the material was furnished or for whom labor was performed.

Once things go south on a project, it can be difficult to get the name of the Principal’s bond company (Surety). It’s a best practice to get a copy before the job begins. Although I often hear pushback, this is your right on a public project and a best practice on private work as well. You can read more about verifying surety bonds here.

What to Look for in a Payment Bond Company

The contract documents will outline the requirements for the Surety company writing your bond. Many will require that your Surety be rated “A-“ or better by the rating agency A.M. Best. You can check that here (registration required). Contractors should be very suspicious about using a bond with a lesser rating. Most contracts will also require your Surety to be listed on the U.S. Department of Treasury’s Circular 570 which you can check here. This is sometimes shorted as a “T-Listing”.

Indemnity Required

A payment bond is a type of surety bond and surety bonds are written on the principal of indemnity. This means that if the bond company suffers a loss, they will seek reimbursement from the indemnitors. Before getting a performance bond, the company and often the owners will be asked to sign a General Indemnity Agreement. You should read this agreement carefully before signing it as it spells out the terms and conditions of all indemnitors. This is one major difference between surety bonds and insurance. Contractors can read more about indemnity here.

Other Resources

Payment bonds can be confusing but they do not have to be. Visit our Frequently Asked Surety Bonds Questions Page here. We also update our blog with useful information and you can also contact us anytime with questions.