How Does a Payment Bond Work?

There are several types of surety bonds that are important to the construction business, but just knowing what they are isn’t enough to take advantage of the opportunities in bonding. It’s important to understand how a payment bond works and how it applies to your bidding on a job. 

Before covering how do payment bonds work, we’ll discuss what they are and the process by which a contractor can get one from a surety provider, and why payment bonds are a necessary part of working as a contractor. 

 

What is a Payment Bond?

A payment bond is a type of surety that guarantees to laborers, subcontractors, and material suppliers that they will be paid according to the terms of a contract. You’ll see them required if bidding on public projects or, sometimes, a general contractor will require a payment bond from their subcontractors to ensure they pay out their laborers as well.

While it can be tempting to see a payment bond as a form of insurance, there are several differences that should move you away from thinking of payment bonds in that way. For example:

  • Payment bonds don’t protect the contractor who was issued it
  • The bond benefits the laborers, suppliers, and subcontractors in case they aren’t paid according to the contractual terms.
  • The contractor would have to reimburse the surety provider if a claim is made against it. 

Essentially, a payment bond protects those working for a contractor on jobs from being swindled out of what they are owed. 

 

How Do Contractors Get Payment Bonds?

How do payment bonds get issued is a question many contractors have when interested in bidding on a publicly funded project. The process isn’t complex but involves reviewing prior experience as well as financial information for your business as a surety provider wants to ensure that you have the experience and financial capability to complete the jobs you’re being bonded for. While the specifics of being issued a payment bond can depend on the size of the bond you need, there are a few areas that remain constant in the process.  Here are some of the topics a surety provider will want to review:

  • Do you have the labor and equipment to finish the job you’re seeking a payment bond for?
  • What is your track record of profitable jobs that you’ve completed?
  • Financial statements from both the company and the owner will likely be required by the surety provider if the bond size is over $750,000.
  • Your personal credit is likely to be a factor
  • Do you have the internal controls to account for and manage the job?

Each of these topics are common in the process for qualifying for a payment bond, so it’s a good idea to be prepared to answer them and provide the documentation needed.

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How Does the Bond Work?

A payment bond works similarly to a mechanic’s lien in that the bond will ensure subcontractors, laborers, and the material providers are all paid if the contractor is unable to do so. This situation can arise from a number of factors, such as the length of a construction project and the finances required during that time. 

The payment bond ties together three separate parties:

  • The obligee (The entity who requires the bond.  Typically the project owner but it can also be a general contractor.)
  • The principal (The contractor who obtains the bond.)
  • The surety (The company that issues the bond and guarantees payment.) 

If a laborer, supplier, or subcontractor is not paid properly by the contractor, the wronged party(s) can file a claim on the bond. If that claim is found to be valid, the surety that provided the contractor the bond will provide payment to the wronged party. 

 

Why is Bonding Necessary?

There are two primary reasons why payment bonds are required for public projects:

  • Mechanic’s liens cannot be placed against public property
  • Help to prevent frivolous bidding by shady contractors

What the payment bond helps to prevent is a resurgence of failed construction projects that used to be fairly common over a hundred years ago. This resulted in taxpayers having to foot the bill for jobs that weren’t finished and were necessary public work projects. To stop this from continuing, the federal government passed The Miller Act, which required both performance and payment bonds to be used on projects funded with tax dollars. 

Payment bonds are an important part of protecting both taxpayer money and the laborers, subcontractors, and suppliers who aren’t directly contracted with the owner of the project. 

 

Payment Bond Specialists

Now that you understand how a payment bond works, why it exists, and the process to get the bond, the next question is:

Who do you work with to get a payment bond?

Some contractors turn to their long-term insurance agents for their surety bond needs, but that isn’t the best option as we explain here: Surety Bond vs. Insurance Policy: What’s the Difference – CSBA

Instead, it’s important to work with a surety specialist that has a deep understanding of the bonding process and how it relates to contractors in California. 

Here at CSBA, we are committed to helping contractors navigate the financial seas of the construction industry and improve their understanding of it, which is why we write on these subjects extensively. That is one of the ways we separate ourselves from other sureties, helping contractors grow their success and focus entirely on surety bonds themselves. It’s our profession and our expertise. 

Partner with the payment bond experts and find a new ease in getting bonded.

Shaunna Ostrom.
About The Author

Shaunna Ostrom

Senior Underwriter

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