Mechanics liens generally provide strong protection to construction industry participants on private projects, but when the underlying property being improved is publicly owned, it can’t be encumbered or sold to force the payment of the amount due. Because of this, construction participants on most public works projects are protected by a payment bond, a pile of money taking the place of the property itself. A claimant looking to recover money owed would then file a claim against the bond, instead of the public property.
In order to discuss the appropriate ways in which to pursue or defend a bond claim in any meaningful way, some background on what payment bonds are, and how they work, should be provided. Bonds, at least as related to construction projects, can be divided into three primary types: bid bonds, performance bonds, and payment bonds. This article will focus on payment bonds, specifically.
What is a payment bond?
“A payment bond is a surety bond posted by a contractor to guarantee that his subcontractors and material suppliers on the project will be paid.” While this is not a precise legal definition, it provides a clear basis for the concept underlying the payment bond. On a project on which a payment bond is required, the purpose of the bond is to ensure the payment of parties lower on the contractual/payment chain than the contractor obtaining the bond.
Payment bonds are required on federal projects of a certain size, and also by every state on public construction projects that meet or exceed a certain specific threshold value. This initial contract value floor for state and municipal projects is set by each state individually and varies from requirements that all public projects be bonded to not specifically requiring bonds unless the initial contract is for more than $500,000. However, as a practical matter, most substantial public works projects require the prime contractor to obtain a payment bond.
In a nutshell, a payment bond provides the same protection against nonpayment on a public project that the property itself generally provides on a private project. If subcontractors, suppliers, or other lower-tiered parties are not paid, the bond provides a type of security against which they can make their claim for payment.
How do payment bonds work?
As alluded to above, a payment bond claim on a public project is analogous to a mechanics lien filed against a private project. Where a mechanic’s lien secures a debt by an interest in the underlying property itself, a bond claim provides a remedy against the general contractor’s bond, backed by the surety. The bond, which is generally required to be an amount sufficient to pay the claims of all lower-tiered parties, provides a “fund” against which unpaid parties may make a claim, and ultimately get paid.
The bond claim process is similar to the process of filing a mechanics lien. This means bond claimants are subject to the same common mistakes that plague mechanics lien claimants. Many states require sending some sort of preliminary notice, so it’s imperative that potential bond defendants track the notice requirements in the project state, so that they can determine whether the potential claimants have complied with the requirements. Most often, the preliminary notice requirements for bond claims are entirely different from the preliminary notice requirements for mechanics liens in the same state, so checking the state’s Little Miller Act statute is important.
After any required notices have been given, a party who remains unpaid may file a claim against the bond. This step is similar to making a mechanics claim in that there are specific deadline, form, and service requirements. It differs from a mechanics lien claim in that in almost all instances, there is no actual “recording” of the document required. The parties required to receive the bond claim differ by state, but usually include at lease the bonded prime contractor, and generally the public entity, as well. As mentioned, while generally not required, a small minority of states do specify the bond claim must also be filed with the county recorder. Finally, and also similar to mechanics liens, a bond claim will be extinguished after a certain amount of time passes. If the deadline to enforce passes, the claimant will no longer have a right of action against the bond to recover payment.
Common mistakes to avoid: Defending a bond claim
Not knowing preliminary notice rules
The same preliminary notice requirements that the bond claimant must pay special attention to work in favor of the party defending a bond claim. Failure of the claimant to give the required notices by the specific deadlines can render the claim invalid, and make its defense much easier.
But, the fact that that party doesn’t need to give the notices is not an excuse to be ignorant of the specific requirements. It’s important for the general contractor to be aware of the notice requirements, in order to determine if the requirements were met.
If notice is required and not received within the mandated time period, defending any subsequent claim against the bond becomes that much easier. If a bond claim is made, the information that no required notice was provided can be given to the surety at the same period of time it is notified of the claim.
Not knowing or checking on “filing” requirements
For a party defending a bond claim, the same considerations given to preliminary notice should be given here. Failure of the bond claimant to comply with the specific rules can invalidate the claim. If the bonded contractor is aware of the rules, it is in a much better position to defend itself than a contractor that is unaware of those rules.
Just like for bond claimants, bond defenders should also make it a routine practice to retain information that would be beneficial in the event a claim is made. Just like the surety will request additional information and support from the claimant, additional information and support will be required from the prime contractor as well. Having the information handy, and providing it quickly, will be beneficial. Sureties will generally stick with a bonded contractor’s arguments if they are well documented, and well organized. Providing information supporting the position that payment is not necessary can increase the likelihood of success.
Hiding the claim from the surety company
Also, it is too common for prime contractors to wait to provide the surety with notice of the claim itself. This is a mistake. Sitting on a bond claim and not providing it to the bonding company can strain the already potentially tenuous relationship between the bonded contractor and the surety. Further, the requirements of the bond will generally specifically require the prime contractor to notify the surety of any bond claim within a certain time period.
Failure to do so can provide the surety with a defense to paying the claim – which means that 100% of the liability (and, potentially, the legal costs of the surety) will be passed on to the prime contractor. This can be avoided simply by passing the claim along when received.
It is also important to note that if there is any undisputed portion of the claim, that portion should be paid. Failure to pay even when the right to payment is undisputed can open a company up to much more exposure than originally bargained for.