Not all bonds are created equal

Sept. 1, 2010
Understanding the legal aspects of payment bonds

New residential construction is down. New commercial construction is stuck in neutral. Expansion and renovation is on hold. The only work in many communities these days seems to be public work. Well, at least you have the consolation that you will be paid because, aside from everything else, the contractor will have to have a payment bond to protect you, right? Bonds prove that there will be a big, solid company standing behind the obligations of contractors. Don't they?

Well, maybe … Not all bonds are created equal, and not all subs and suppliers are not going to be on the same footing either. If you have any doubt that you will be paid and paid on time (and honestly, how could you not have some doubt?), it would be well worth your time and effort to check the words of the law itself, and check with an attorney to understand how the law will affect your rights.

If you are working on a project that could be considered "federal" it may, or may not, fall under the Miller Act, 41 United States Code. If it is a Miller Act project, the form of the bond and what it covers will be easy to pin down. That may be good for you (if you are covered), but at least you will be able to know. But remember not all projects involving the U.S. necessarily require Miller Act bonds, and even if they do, but the contracting officer makes a mistake and forgets to require one, neither the U.S. nor its employees can be held liable to the unfortunate subcontractor who is left unpaid. So, it is worth the effort to ask for a copy of the bond before starting work on any supposedly federal job.

Most, but not all, state and local governments are required by law to in turn require surety bonds of their contractors, but again, this is not a universal requirement, and may not only vary from state to state and agency to agency, but also be subject to dollar limits below which bonds are not required. And although some states specify the content of the payment bond, not all do, which leaves the subcontractor with no assurance that its claims will be covered.

Private projects are an increasing source of new payment bond business, as more lenders and title companies are requiring them as a condition of financing. While lien rights may still exist in this situation to protect subs and suppliers, again, you can't count on them. Many states will enforce contracts which require contractors to give up their lien rights as a condition of getting the work, and even where that is not enforceable, they will generally allow a lender to require the contractor or sub to "subordinate" lien rights to the lender's mortgage (and if the mortgage gets filed before the contractor starts work, the contractor's lien rights will often come second anyway). So, that bond may be your only source of payment.

And just as lenders and title companies are tightening the noose around their borrowers' necks, general contractors are finding that their own sureties are requiring that they lay off some risk by requiring surety bonds of subcontractors. This can give an unpaid sub-subcontractor or supplier yet one more place to turn in the event of non-payment by a bonded supplier or subcontractor.

For these bonds to give any sub or supplier comfort, however, the sub supplier needs to have done his homework. He needs to get a copy of the bond, to verify that it was in fact provided and is binding on the surety. He also needs to check out the surety. Make sure it has the assets to pay. If you are currently working with a surety agent now, that agent can help you investigate the bona fides of the bond and the surety. He also needs to read the form carefully. If the surety has the option to provide the form (that is, if the owner/GC/statute doesn't specify the form), you could easily get a bond that is difficult if not impossible to make a claim on.

Also, there are a few things to consider when making a claim and filing a suit: Do you have to wait a long time before you can make a claim? Some forms have such a long waiting period that your lien rights could have expired before you can make a claim. Do you have a short time frame to make a claim? Do you have a short time frame to file suit? How do you know what to submit with your claim?

The American Institute of Architects has recently worked with other industry organizations, including the American Subcontractor's Association, to improve its bond forms to cure some problems with them, so they should be more "user-friendly" now, but it is still in your interests to check out payment bonds in advance to make sure that they will be of use to you later if a problem arises.

Susan McGreevy is a partner at Stinson, Morrison, Hecker LLP, Kansas City, Mo., 816/842-4800, e-mail to [email protected].

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