Professionals in the construction industry are well aware of the importance of surety bonds. Surety bonds are issued by surety companies and function as a guarantee between workers and project owners that all terms outlined in the bond will be followed to the letter. There are various bonds available for a multitude of purposes. Some of them provide protection to the workers themselves, while others are meant to provide protection to the owner. Among the available surety bonds that can be pursued, one is the payment bond. This one is classified under bonds that provide assurances to the workers.
What is a Payment Bond?
Based on the name alone, we can take away that these specific surety bonds revolve around payment. In the construction industry, payment bonds serve to protect subcontractors, labourers and material suppliers. The guarantee provided functions as a contract between these parties and the project owner, as the latter is assuring the former that they will all be provided with their respective payments in a timely fashion without any extended delays.
At the same time, the subcontractors, suppliers, etc. also get protection, in the sense that they can file a claim if the payment isn’t received within a reasonable period. By filing this claim, the surety company can then provide them with some kind of compensation for the inconvenience.
Is it the Same as a Performance Bond?
Due to the fact that there are a multitude of construction surety bonds, people often get confused and assume that certain bonds are essentially interchangeable. This same problem affects performance and payment bonds.
As expanded on above, a payment bond exclusively revolves around payment. It is meant to protect the interests of the professionals directly working on the project by assuring that they will receive financial compensation for their contributions to the project.
By contrast, a performance bond has absolutely no ties to payment. As can be inferred from its name, it’s entirely concerned with the performance of the aforementioned professionals. Therefore, this surety bond serves as protection only for the project owner, guaranteeing that the developers, suppliers and labourers will complete the project in line with what the owner has requested; they are to do no more and no less than what is described in the performance bond.
Clearly, upon closer inspection, it’s fairly easy to dispel any confusion regarding the nature of performance and payment bonds. Any perceived similarities are on an extremely shallow level.
Who Are the Parties Involved?
It’s been mentioned above that the protection and guarantees of the payment bond are meant to provide assurance to subcontractors, labourers and material suppliers, with the project owner being the one providing the assurance.
In legal terms, however, these parties are designated different titles. These would be the Obligee, the Company and the Principal. The obligee refers to the parties who are requesting the bond, as in the people who benefit from the bond. The company is, of course, the surety company that issues the bond in the first place. Lastly, the principal is the one who carries responsibility for obtaining the bond. Generally, this can be any person, company or entity. Specifically, in the construction industry this role is occupied by the contractor.
In most cases, you will begin pursuing the payment bond after the project owner has accepted your bid for the job. Additionally, it is recommended that all necessary bonds should be pursued and acquired prior to beginning any work on the project.
Note that it is stated above that the contractor is usually the principal in the pursuit of these bonds. However, this is not always the case, because there are also times when subcontractors can directly play this role themselves and acquire possession of the bond.
Is it Mandatory?
The initial answer would have been no. However, currently it is necessary to obtain payment bonds for your public construction projects. This has come into effect from July 2018, when certain changes have been made to Ontario’s Construction Act. As such, contractors who are committed to public projects must acquire payment bonds. Otherwise, they will not be allowed to begin any work on the project.
Additionally, in regards to private projects, it’s advisable to obtain a payment bond because there are certain localities and municipalities that require them anyway. Plus, as a contractor, you have nothing to lose and more to gain by having a payment bond in your possession.
What are the Requirements?
When applying for a payment bond, the primary concern of any surety company or underwriter is the financial strength of your company. You need to be able to prove to the underwriter that you are in a secure position. To that end, you need to provide balance sheets, financial statements, etc.
There is a great deal of information you need to be able to provide and it’s advised that you organise all relevant financial documentation before you apply for the bond. This will help you save a lot of time. While each underwriter can potentially give priority to different information, it’s always better to have all the information compiled so the underwriter can see for themselves what is most relevant to you.
Additionally, your personal credit is also likely to be a contributing factor. Approval is always easier for those that can show they have a good credit score as opposed to a negative one. Those with negative credit scores don’t necessarily get rejected outright, but they most definitely do have to confront some rather expensive rates.
How Much Do They Cost?
There isn’t one standard cost for payment bonds (or any bonds). How much you will be charged is entirely dependent on whether the underwriter feels your company is reliable and trustworthy. For example, companies that have been in construction for a longer period of time are likely to be more trusted as there are years’ worth of financial details to support their reliability. Upstart construction companies still have a lot to prove and so might struggle a bit more. However, this isn’t to say that no one will issue a bond to a newer company, just that it might be a bit more challenging.
Also worth noting is that the amount you will be charged depends on the total cost of the project combined with the type of bond being pursued. The amount you pay is referred to as a premium and it requires you to pay a percentage of the total bond. This premium is dependent on various factors, and among them is your personal credit score. As mentioned earlier, those with a healthy credit score benefit from premiums as low as 4 percent. However, those with a bad credit score will be required to pay much more than that.
Note that surety companies need to examine and analyse a wide range of financial information to properly determine the most practical amount to charge you. Therefore, the process might take a fair bit of time before being completed.
When it comes to bonds, it’s very important to have provisions for occasions when the terms haven’t been honoured. Payment bonds have these provisions in the form of claims. As briefly mentioned earlier, subcontractors, material suppliers and labourers can file a claim if they are not provided with their respective payments.
After filing a claim, the surety company can then begin an investigation on their end to conclude whether the terms of the bond were followed or not. After they have completed their research they will either side with the contractor or the subcontractor/labourers. If they side with the subcontractor and labourers, these parties will be provided with financial compensation for the work they were involved with. The surety company pays the necessary amount. With that problem addressed, the surety company will then begin pursuing the contractor so that they can regain their losses from having paid off the obligees of the bond.
As a contractor, this might sound very concerning. However, it is fairly easy to resolve. As soon as you receive word of the claim being filed, it’s in your best interest to contact the obligees and negotiate with them to arrive at some kind of compromise. To prevent the situation from escalating too far, open communication can usually make a big difference.