What Is A Payment Bond?

Posted: December 11, 2018

A payment bond is a type of surety bond commonly used for public and private construction projects. These bonds are usually issued in conjunction with a performance bond. Its purpose is to ensure that the contractor pays the companies that supply materials for the project as well as the subcontractors and laborers working on a project.

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Why Are They Important?

Delays in payments can result in delays in completing the project. Nonpayment can result in liens being placed on the project. Nonpayment of suppliers and workers usually occurs when a contractor is running out of money and about to default on a project. The most common reason that contractors default on projects is insolvency or bankruptcy. A payment bond ensures that taxpayers (if it’s a public works project) or investors (in a private construction project) don’t get stuck with a project encumbered by liens if the contractor fails to pay suppliers and/or workers.

Who Needs Them?

A payment bond, along with a performance bond, is required by law for all federal contracts over $100,000. Most states have a similar requirement for large state-funded public works projects, and many private construction project owners also require contractors to obtain payment bonds. In competitive bidding situations, bidders may be required to post a performance bond and a payment bond along with a bid bond.

How Does It Work?

The three parties involved in a payment bond are:

  • The obligee. The project owner requiring the bond
  • The principal. The contractor that purchases the payment bond
  • The surety. The company that underwrites and issues the bond

The bond protects the obligee from having liens placed against the project if the contractor doesn’t pay supply and labor bills, which would ultimately take money out of the pockets of taxpayers or private investors.

If the contractor fails to pay their bills, suppliers, subcontractors, or laborers can submit claims against the payment bond. The surety will investigate to make sure that each claim is legitimate, and will then pay any valid claims. Ultimately, however, the contractor is responsible for repaying the surety for every claim the surety pays against the bond. The surety has the right to sue the contractor for repayment, if necessary.

How Much Does It Cost?

The cost of a payment bond depends on two factors: the total bond amount required and the premium rate assigned to the bond applicant. The obligee determines the amount of the bond based on the size of the contract and establishes a premium rate after evaluating the applicant’s credit. The premium ranges from .5% for companies that meet “excellent” underwriting requirements to 3% for those with less than stellar credit or who fall into other non-standard underwriting criteria.

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Contractor Surety Group is an underwriting agency specializing in P&P bonds for developers/GCs including LIHTC (4% & 9% deals), market rate, HUD 221 (d) (4), and state-based programs. Whether you need a payment bond only or a payment and performance bond, our experienced professionals will gladly help you.

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