How Do Performance And Payment Bonds Work?

A payment bond is usually one of the requirements in most construction projects, both private and public. Typically it is issued along with the performance bond in the construction industry. The payment bond forms a contract between the three parties, such as the owner, the contractor, and the surety. It ensures that all sub-contractors, material suppliers, and laborers will be paid, which leaves the project lien free. The payment bond is usually billed at about 50 percent of the regular premium and is rarely requested.

The surety is known as the company that is licensed by the Insurance Department and the regulatory agencies to create or write the bonds within the state of the country where the work will be executed. The principal, also known as the contractor, promises in the payment bond that the contract agreed upon will be executed according to the specified terms. The surety then promises that in the event that the contractor fails on the payments, it will pay damages to all the demanding parties. This helps ensure the completion of a project and protects the contractor and its subcontractors.

For private projects, the payment bond can be used as a substitute for a mechanics’ lien. When the contractor or principal fails to pay the subcontractors and suppliers, the payment bond allows them to collect from the surety. However, the Mechanic Lien is the type of bond that cannot be used against public property. That is why the payment bond is the type of bond that is commonly required in projects that are funded by the government, whether local, state or federal.

The payment bond appears to be the only tool or option that some subcontractors and suppliers have so that they can get paid for the service and labor. Today’s project owners are now using the subcontractor default insurance, which is in conjunction with the payment bond and performance bond. Many jobs that involve private property projects also take advantage of performance bonds and the protection it provides them.

Local, state, and federal laws all mandate that payment bonds, performance bonds, and bid bonds should be utilized for most public projects. For all projects that exceed $100,000, the federal Miller Act dictates the use of surety bonds. The federal Miller Act requires contractors of public or government projects to post bonds to guarantee both the performance of their contractual duties and also the payment of their material suppliers and subcontractors.

The AIA A312-2010 Payment and Performance Bonds Form is the most used payment bond in the construction industry. This is a new version of the original 1984 AIA 312, which shortens the notice period for the surety with a default of 7 days from the old version that had 15 days. Other changes also include a change in the given period of time the surety must answer a Claimant’s Claim from 45 days to 60 days. The surety’s failure to answer or make payment during the time period may entitle the Claimant to attorney’s fees.

Amidst the common use of the 2010 AIA 312, many bonding companies, such as obliges, sureties, and principals, are still using the 1984 AIA 312 version because it allows them to amend the bond language to the specific circumstances of the construction project. The A312-210 Performance Bond adds the language which clarifies the owner’s failure to comply does not release the surety the obligations under the bond and only except when the surety demonstrates actual prejudice.

Payment bonds can also be required without having performance bonds. For this process, the payment bond needs to be purchased during the bidding and must be submitted to the owner once the project has been granted or awarded. It normally specifies the date and time of payment to employees, subcontractors, and suppliers.

When payment bonds are issued along with a performance bond, the premium is estimated to be between 1 percent and 2 percent. The performance bond rates or actual cost may also vary depending on the project’s total costs, and the background check, credit history and financial history of the contractor who is requesting the bond. For contractors who have good financial history and credit, they can expect to pay a fee which can be 0.5 percent to 5 percent amount of the bond’s full value to get the bond.


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