What are private project performance bonds and how do they work? Construction is a very risky business but several tools have been developed over time to reduce these risks. You’ve likely seen many of these tools when working on construction jobs including insurance, retention rights, off-set, and risk apportioning indemnity agreements. One powerful tool which is not regularly used on private construction projects are payment and performance bonds.
When public money is funding the construction
On public projects, payment and performance bonds are by law because the “owner” is a governmental entity using tax dollars to fund the project. Since public money is funding the construction, extra guarantees are needed to ensure the successful completion of the project to prevent loss of our hard-earned tax dollars. Also, mechanic liens are not allowed to be filed against public property, so the payment bond acts as the alternative protection for non-payment of subcontractors and suppliers.
Private Project Performance Bonds
Payment and performance bonds can also be used for private projects even when no public funds are at risk and filing mechanic liens against the project property is an option. These bonds on a private project provide the owner with the same protections as on a public construction project. The difference is, the contract between the owner and general contractor requires the general contractor to furnish a payment and performance bond. The general contractor purchases the bonds from a bonding company, often referred to as a “surety”, for a fee equal to a small percentage of the bond value. The surety then acts as a guarantor for the general contractor’s contractual payment and performance obligations.
What happens when there’s a failure to perform?
If the general contractor or one of its subcontractors is unable to complete a portion of the work correctly or on time, the private project performance bonds kicks in. The surety assesses what is causing the delay or the faulty work and acts as a liaison between the relevant parties to formula a plan to correct the work. If the surety is unable to fix the problem by working with the parties, then the surety has two options.
The “Tender Option”
The first option is the “Tender Option” which means the surety offers the owner a new contractor who can take over the work. The owner will remove the previous contractor and work with the new contractor to complete the work. The second option is the “Take Over Option” which means the surety itself takes over the work completes the work itself. If either of these options are used, the general contractor must reimburse the surety for the costs of fixing the performance problem.
What happens when there’s a failure to pay?
As the owner makes payments to the general contractor for the work and materials to complete the project, the owner expects those payments to flow down to every tier of subcontractor and supplier under the general contract. If a subcontractor or supplier is not being paid for its work or materials, it must submit a claim against the private project performance bonds to the surety. Like with the performance bond, the surety steps in to investigate the non-payment claim and assist with a resolution, if possible.
the surety will pay you for your work
If the claim is found to be legitimate and you are owed money that has not been paid, then the surety will pay you for your work and materials. The surety will then go to the general contractor to be reimbursed for the money it paid to you. Also like the performance bond scenario, if the general contractor is not the cause for the non-payment, the general contractor must still reimburse the surety and seek its own reimbursement from the defaulting party.
So should I use a Private payment bond or my state’s mechanics lien system?
It may sound like the private project performance bonds are a lot easier than the typical mechanics lien process. While this is somewhat true, there may still be several requirements you must meet to file a proper bond claim. Each bonding company has its own rules for submitting a claim for non-payment. While these requirements may be simpler than a typical state mechanics lien system, you should still seek assistance from a construction payment expert.
