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 type of surety bond called a payment bond, a pile of money taking the place of the property itself, and against which the claimant can recover.
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. Surety 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.
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What Is a Payment Bond?
A Payment bond is a type of surety bond that is typically acquired by the prime contractor on a construction project to protect all the subcontractors and suppliers below them on the project from the risk of non-payment.
While this is not a precise legal definition, it provides a clear basis for the concept underlying the payment bond. For a construction project on which a payment bond is required, the purpose of the bond is to ensure the payment of all the other companies participating on the project that are below the contractor (usually, but not always, the prime or general contractor) that obtained the bond on the project payment chain (see illustration).
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 security 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 process by which a claim is made against a payment bond 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 claimants track of the notice requirements in the project state. 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 least 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 similarly to mechanics liens, a bond claim will expire 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.
The Payment Bond Claim Process
1) Preserve Your Bond Claim Rights By Sending Required Notices
Damn, you’re probably thinking, notices are required on state construction projects too? I have unfortunate news to you. Not only are preliminary notices sometimes required on state and county construction projects, but they are frequently entirely different requirements from those on private projects in the same state (but not always).
As with private projects, it’s important to know and understand the notice requirements in your particular state. Send the notice that is required, maintain proof of sending or delivery, and do it at the very start of furnishing.
2) If Unpaid, Send a Notice of Intent
A Notice of Intent is different from the Preliminary Notice. A Notice of Intent comes after a payment issue has occurred on a project, but before a bond claim is submitted. A Notice of Intent is like a demand letter — one final warning that you remain unpaid on a job, then there will be consequences. (The “consequence” in this case being a bond claim.)
Typically, this optional notice is sent to the general contractor, but sometimes it must go to the surety or the public authority. Again, time frames will vary from state to state, so adhering to the requirements for a bond claim should be priority number one.
Even though a Notice of Intent is generally not a required document, our recommendation is to go ahead and send it anyway! Better to give the recipient one final warning – and one last opportunity – to pay you before you’re forced to proceed to the next step.
By sending such notice to the GC, the surety, and the awarding authority, all parties become aware that a payment dispute has occurred. Sending the notice of intent to everyone at the top of the payment chain will create pressure to settle the payment dispute.
3) If Still Unpaid, Timely File Your Bond Claim
If you remain unpaid even after sending the Notice of Intent, it may be time to lodge your bond claim. There are two issues to consider:
- (i) When must the bond claim be filed; and
- (ii) How is the bond claim filed.
Both of these questions are answered differently from state to state, although there are a lot of consistencies in states that have adopted a standard “Little Miller Act.”
Making an official claim on the bond – sent to both the GC and the Surety – should always be a step in the recovery process for public projects (plus, it’s usually required!).
Submitting a bond claim, at times, can be more complex than filing a lien claim. Typically, bond claims are “filed” by sending the claim via certified mail, return receipt requested to the required parties. The “required parties” that must receive the claim will vary by state, but it will be some combination of the GC, the Surety, and the Public Authority.
4) If Still Unpaid, Send a Notice of Intent to Proceed Against Bond
After a bond claim is filed, there’s can be another step. Whether the claim was rejected, ignored, or the dispute is ongoing, filing suit against the bond is sometimes necessary for recovery. Typically, a suit against the bond must be filed within one year- but that’s not always the case. Again, it’s imperative to be aware of your state’s specific requirements – even if a dispute is ongoing or feels like a resolution is right around the corner, losing the ability to file suit takes away your strongest leverage during negotiations.
Contractors do not want claims against the bonds they post. Their bond history will directly affect the cost of acquiring bonding moving forward, so threatening to file suit against the bond just might light a fire under the GC’s rear-end which could result in payment.
If nothing else, a Notice of Intent to Proceed Against Bond will give the GC one last chance to pay up before taking to the courts. Since this is not a required document, it merely needs to be sent within the timeframe to file suit against the bond. It’s best practice to allow the contractor some time between sending this notice and filing a bond claim, but if deadlines are coming on quickly, don’t delay filing suit.
Best Practice: Get a Copy of the Payment Bond on State Projects
The payment bond becomes the center of the universe when payment problems arise on public construction projects, and so it’s surprising how many project participants work on these projects without the payment bond in-hand.
Well, guess what?
You’re Entitled to a Copy of the Payment Bond
Remember this statement: You are entitled to a copy of the payment bond. No if’s, and’s, or but’s about this. On construction projects in nearly every state and county, if the project is a public work, the state laws provide that you must be provided a copy of the payment bond upon request. You’re usually allowed to request it from either the prime contractor or the public entity commissioning the work.
How to Get a Copy of the Payment Bond
Now that you know you’re entitled to a copy of the payment bond, you may be wondering: how do I get it?
Each state has slightly different procedures for requesting a copy of payment bonds, but in general, a formal written request is required from the party who is providing labor and/or materials to the applicable project. These requests are typically sent to the prime contractor or the public entity commissioning the work, and they are sent by certified mail or certified mail with return receipt requested. In a minority of cases, the requesting party must actually provide a notarized affidavit affirming that they are furnishing to the project.
In states where preliminary notices are required on state construction projects, it’s a good practice to actually include this request within that notice. Whenever a preliminary notice is ordered from Levelset, we have that formal request for information built into the notice form. This ensures that the potential lien claimant gets a copy of the payment bond at the very start of construction.
Why It’s Important to Get a Copy of the Payment Bond
There are two primary reasons why it’s important to have a copy of the payment bond on a state or county public works project:
- (1) It identifies the bonding company for you; and
- (2) It identifies the terms of the bond.
First, knowing who the bonding company is can be critical to making a timely bond claim. In many states, you’re required to deliver your bond claim to the bonding company within a certain period of time. It’s obvious that you can’t send the claim to this party if you don’t know who they are. If you wait to investigate the identity of a surety just before a bond claim deadline, when tempers may be a bit more uncontrolled because of payment problems at the project, you may be left with a tall order – which, unfortunately, can impact your ability to make a claim.
Second, getting a copy of the payment bond discloses to you the terms of that bond. Payment bonds always have legal terms. Many potential bond claimants overlook this because there is so much focus on the state or federal rules governing the bond claim, but nevertheless, they exist, and there are a handful of situations that can arise when your bond claim is compromised because of a failure to comply with the terms of the bond.
Common Mistakes to Avoid: Making a Bond Claim
Most of the common mistakes to avoid in the bond claim process spring from the complexities of the process itself, or from the mistaken belief that mere compliance with the requirements will best position a claimant to be paid.
Payment Bond Preliminary Notice Problems
Many states mandate that preliminary notice be sent within a certain time period, at the risk of invalidating a subsequent bond claim. Failing to provide this notice when required, in the manner required, and to the parties required is all too common.
The laws of the project state should be reviewed, and any required notice provided. Many of these preliminary notice deadlines, when applicable, provide a relatively short period of time in which to give the notice, so it is a good idea to get familiar with the laws of the project state prior to involvement on the project.
For example, on public construction jobs in the state of Arizona, any party who did not contract directly with the prime contractor must provide a preliminary notice within 20 days of first furnishing labor and/or materials to the project, and this notice must be provided to the prime contractor. Subs and suppliers working on public construction jobs in the state of California have the same 20-day requirement for parties who didn’t contract with the prime contractor, but instead of only providing the notice to the prime contractor, they must also be provided to the public entity. Failure to comply with the complex notice requirements is a common mistake that can derail a bond claim before it is even made.
Further Reading: Don’t Surprise the Surety – Streamline Getting Paid On Bond Claims
Payment Bond “Filing” Problems
Just like providing preliminary notice, the filing of the bond claim itself is technically precise and subject to specific requirements. If required, bond claims must be made within a certain amount of time. Missing this deadline should be completely avoidable, but is a common mistake that invalidates many claims. Just like with preliminary notice, this mistake can be avoided by a thorough review of the laws of the project state.
Along with making the claim within the set time period, the claim must be provided to the required parties. Failure to do so will invalidate the claim. However, not only must the claim be provided to specific parties – the claim should be provided to other parties, as well.
Very few states require bond claims to be provided to the surety, but it can have a dramatic, positive impact on the claimant getting paid. Relying solely on compliance with the state rules, and neglecting to provide copies of the bond claim to every party “up-the-chain” from the claimant can be a costly and time-consuming mistake.
It is not uncommon for parties who contract directly with the prime contractor to have no formal requirement to make a claim on the bond in any manner prior to initiating suit. This is a bad idea. Even if no strict requirement to make a claim prior to filing suit exists, it is always a good idea to provide notice of the claim to the general contractor, the public entity, the surety, and the hiring party.
Finally, once the claim has made its way to the surety, more information will likely be required. For this reason, information and documents that back up the claim should always be retained, easily accessible, and should be provided quickly if requested. After the information has been provided, the claimant should routinely check in with the surety claim representative to check on the status of the claim, and see if anything else is needed. Many companies fail to take these easy steps even though the amount of energy necessary to do so is routinely paid off in the claim being paid more quickly and without the need to file suit.
The Problem of Not Checking-Up on the Payment Bond Claim
After a bond claim is received and provided to the surety, it’s likely that the surety will require the claimant to provide more information and supporting documents. After this point, the claim will either be paid or denied. But, as with every other step in the bond claim process, it is important to monitor the progression here, as well.
Just like there are set deadlines by which a bond claim must be made, there are also set deadlines by which a bond claim must be enforced. Failing to check up on the claim and provide all the supporting information timely can cause the enforcement deadline to slip by – which renders the claim unenforceable and relatively worthless.
Being careful, and making sure these common problems are not overlooked, can mean the difference between getting paid and having an unenforceable claim. Don’t lose your right to get paid to a technicality! When it comes to managing a bond claim, you’ve got to mind your P’s & Q’s.