What Are Payment Bonds?

Payment bonds are also known as surety bonds. A surety is a promise made by a guarantor or surety to pay one party a certain amount if the other party or second party fails to meet or fulfill the terms of a contract. It helps protect the obligee party against any losses that would result in the failure of the principal party to meet the obligation that is stated in the contract.

Payment bonds or surety bonds are defined as a contract among the obligee, principal, and the surety. The obligee is the party who is the recipient of the contract obligation. The principal is the primary party who is tasked to perform the contractual obligation. The surety is the one who assures the obligee that the principal party can perform the task.

It is posted by a contractor to guarantee and give assurance that its material suppliers and subcontractors on the project will get paid. A payment bond is required in contracts that are over $35,000 with the Federal Government and it must be 100% of the contract value. They are also most often required in conjunction with performance bonds.

Performance bonds are also known as contract bonds. It is a surety bond that is issued by a bank or insurance company to guarantee or give assurance of satisfactory completion of a project done by a contractor. It is also known as “good faith money,” which is intended to secure a margin or futures contract. In finance, the futures contract is a standardized forward contract or a legal agreement to buy or sell an item, property or something at a predetermined price at a particular or specified time in the future.

In the US, all construction contracts that are issued by the Federal Government are required to be backed up by performance and payment bonds under the Miller Act of 1932. America has also enacted the Little Miller Act statutes to require payment and performance bonds on any State-funded projects. Contractors who work in federal or state projects in the amount of $100,000 or more in order to obtain both payment and performance bonds.

There are more than 25,000 types of Surety bonds in the US and with each having its own designated bond amount.  Most surety bond companies determine their bond rates based on risk. They charge 1 to 15% of the bond amount as surety bond premium.

In case contractors do not fulfill their contracts, the payment bond serves as protection for subcontractors. It can offer subcontractors, laborers, and suppliers legal recourse against the contractors and allows them to file a claim against the payment bond within a given period of time. This will allow the opportunity to receive compensation by the surety.

Contractors should always strive to fulfill their contracts and avoid claims. Once a claim is initiated and is found to be legitimate, obligees, such as subcontractors, suppliers, and laborers, can expect to be compensated for the losses accumulated up to the full amount of the surety bond full payment.

Aside from federal and state projects, many private construction projects also require contractors to secure bonds. Usually, in these types of private projects, the scope of the payment bond’s protection is stated and specified in the contract and bonding agreement.

As a prerequisite requirement for contractors, they must also be licensed. They have to be bonded in their state where they are to operate with a contractor license bond in order to be legally allowed to perform contractor work.

Performance and bid bonds are often issued together with payment bonds.  To enter the bid, you must acquire a bid bond. Then only after by winning the bid, you can secure a performance bond and payment bond before you start working on the project. The same surety bond company generally issues these three bonds as a security measure.

It is impossible to get just a payment bond without the other supporting bonds. But there are rare cases in certain private construction projects that they would only require you to obtain just a payment bond. However, for federal or state projects, you will be required to secure all three.