We talk a lot about mechanics liens and their benefits, but what happens if you are working on a public project and are unable to file a mechanics lien against the property?
That is where bond claims come in. Many people become confused about whether to file a mechanics lien or bond claim. The simple answer is that it usually depends on the type of project on which you have furnished labor and/or materials. Generally, mechanics liens are the proper remedy for private projects, and bond claims are generally associated with public projects: whether state, county, or municipal. Since a bond substitutes a pile of available money for the security of the property itself, it just provides an alternate security for getting paid. Note, however, that there are two different types of bonds, with different roles: payment and performance.
Payment and Performance: What’s the Difference?
The difference between performance and payment bonds is actually simple, yet each bond type is consistently confused with one another. This confusion can cause problems and prevent parties from filing bond claims. Don’t succumb to fear and confusion. Just remember this. The type of bond depends on which party issues the bond and which parties the bond benefits. The way to determine which bond is which is to just examine the name, a payment bond secures payment for work done on the project, and a performance bond makes sure the work on the project is actually performed.
[quote style=”right”]A payment bond is a surety bond posted by a contractor to guaranty that his subcontractors and material suppliers on the project will be paid.[/quote]Payment bonds are issued by contractors and benefit all subcontractor and suppliers below them. Since these bonds take the place of mechanics lien filings, they are generally the bonds that have the majority of claims filed against them. The bond acts as an insurance policy in case the contractor cannot or will not pay the parties below it. In this case, the bond represents a pile of money that parties may make claims for payment against, and steps into the place the property itself providing that security. Payment bonds can ensure that finances won’t dry up, leaving subcontractors and suppliers unpaid. Since public property may not be encumbered by mechanics liens, payment bonds are typically required.
Although the majority of payment bonds are found in public projects, there are a few exceptions for private payment bonds. The procedure for a private payment bond depends on the state you are in. Some states disallow mechanics liens to be filed if there is a bond posted on the project already. Other states do not have specific laws on this procedure. In some cases, a private bond may be used as a reactionary tool to “bond off” a lien against a property. In other words, a bond is posted after the mechanics lien is filed to release the property but still make sure the lien claimant is provided security. Typically, payment bonds on private project are found on large-scale projects.
What is a performance bond? Performance bonds are between contractors and government entities/property owners. This type of bond, as its name implies, ensures performance on the part of the contractor. If the contractor does not perform all the aspects of the contract, the public entity property owner, submits a claim against the performance bond. The surety company issuing the insurance bond then may be required to make sure the project is completed, or cover the full face value of the bond.
Public entities routinely require contractors to post a performance bond in order to bid on any particular project. The federal Miller Act mandates performance bonds be posted for public projects exceeding $100,000. Some states require bonds be posted for public project worth much less. There are no laws that mandate performance bonds for private projects. Despite the lack of mandate, private owners can still contractually require contractors to post a performance bond.
Bond Claims Yield Results
Bond claims can be just as beneficial as mechanics liens and, in certain respects, can be even more effective. Payment bonds give construction parties an option to get paid without the ultimate step of a foreclosure sale of the property. While litigation may still ensue, recovering from a pile of cash has no real difference than recovering through the property itself, and practically, it may be easier. Further, a bond claim brings another party into the mix to help resolve issues: surety companies. These surety companies will apply extra pressure on the contractors to resolve issues. And since sureties will not continue to provide bonds to contractors with claims filed against them constantly, GCs pay special attention to bond claims that are filed against bonds they provide.
Performance bonds, although designed to protect government entities and owners, can be beneficial to the whole project. The main function of these bonds is to protect government entities and owners from contractors that do not complete performance, but indirectly by protecting the top, the lower tier construction parties will benefit. With owners and government entities protected, cash flow issues and work stoppage can be avoided.
Points to Consider
- The project type generally mandates whether a mechanics lien or bond claim is appropriate
- Bond claims are most common on public projects, but some private projects may be bonded, as well
- The bond claim process takes 4 simple steps:
- File a Bond Claim
- Reply to Bonding Company with Backup Documentation
- Followup with the Bonding Company (If Necessary)
- File an Enforcement Action (If Necessary)
- Bond claims provide a similar remedy to mechanics liens, only the claim is made against a pile of money rather than the physical property