Understanding Payment and Performance Bonds

Wed, Sep 18, 2024 at 9:54AM

Trent Cotney, Partner, Adams and Reese LLP

In the construction world, there are a variety of bonds and two of the most used on projects are payment and performance bonds. These two bonds often accompany each other but play different roles during construction.

What is a Payment Bond?

A payment bond is a guarantee that the principal of the bond (contractor) will make payments to subcontractors and material suppliers. These bonds are a type of surety bond and are quite common on construction projects.

In keeping with the provisions of the Miller Act, most federal and state projects require surety bonds. Parties that might require a surety bond include government agencies, lenders, commercial owners and developers.

A surety bond is essentially a contract in which one party (namely, the surety company) guarantees that a second party (the principal) will uphold specific obligations to a third party (such as a material supplier or subcontractor). Payment bonds are obtained to ensure payment if there is a subtier claim.

Background on the Miller Act

The U.S. General Services Administration Public Buildings Service passed the Miller Act in 1935. It applies to any contract exceeding $100,000 that is intended for the construction, repair or alteration of a U.S. government building or public work. It stipulates that the construction prime contractor must furnish a payment bond, which will help protect subcontractors and suppliers. The Miller Act ensures that contractors keep their contractual obligations to the government and that taxpayer funds are protected through the bond. It also provides suppliers and subcontractors a payment remedy if the prime contractor fails to pay them. Before issuing a bond, underwriters evaluate the contractor’s bonding capacity and finances so they can determine the amount of surety credit to extend. The Miller Act bond helps ensure that the federal government selects only contractors qualified to successfully complete a project.

What is a Performance Bond?

While a payment bond helps ensure payment, a performance bond addresses a customer’s satisfaction with the job. Performance bonds are common in many industries, including construction and help ensure the completion of projects. These bonds cover the ability of contractors to perform and finish the job in keeping with the contract requirements.

Three parties play a role with a performance bond: the primary contractor or principal, the surety (the company offering the bond) and the obligee (a third party, usually the owner). If the contractor fails to adequately perform, the surety has a choice of different
options to ensure project completion.

Generally, Florida Statutes Chapters 255 (public projects) and 713 (private projects), govern payment and performance bonds in the State of Florida. There are very specific timing requirements for making claims and prosecuting claims created by statute. Similarly, the bond language itself may have certain conditions precedent to prosecuting claims such as an initial conference between the parties.

If you are a roofing contractor on a private project where a payment and performance bond is not required, I would attempt to have the requirement removed. The cost of the bond premium is passed upstream to the customer and an owner’s representative could ensure timely payment and performance by requiring lien releases before payment and verifying in-progress work in lieu of payment and performance bonds.

Final Thoughts

When there is a claim on either a payment or performance bond, the surety will consider the contractor’s financial stability, assets and credit. Often, a surety may examine the company’s financials or even require collateral be posted for the claim. In addition, the surety may retain separate counsel for the bond claim. Under the terms of the surety agreement, the principal/contractor would have to pay for the surety’s attorney’s fees as well as their own. Recently, there has been a surge of bond claims against roofing contractors and, unlike insurance claims, a bond is often supported by a personal indemnity obligation executed by the owners of the business (and sometimes their spouses). Accordingly, it would be prudent to avoid bonding obligations on projects if possible and strike contractual language requiring the use of bonds.

FRM

Trent Cotney has been named in 2024 Florida Super Lawyers for Construction Litigation, making this his 16th consecutive year being recognized by the publication. Additionally, he has been selected again as a Top 100
Florida Super Lawyer and Top 50 Tampa Bay Super Lawyer. Congratulations Trent!


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