Payment Bonds

In general, a payment bond is an excellent option for construction subcontractors that want assurance of future payment for the construction services they provide.

The Surety Information Office (www.sio.org ) provides materials explaining how surety payment bonds can

But if payment bonds are so useful how is it that virtually every subcontractor knows at least one other subcontractor whose claim was denied by a payment surety, or who feels that he or she was treated poorly in the claims process? How can subcontractors avoid the same fate?

Subcontractor's experience with payment bond claims falls on a spectrum, spanning the perfect, the merely acceptable, and the cataclysmic.

On one end of the spectrum, many payment bond claims are properly processed, without significant problems.

On the other end of the spectrum, some sureties lack the minimum financial resources to cover claims, and some payment bond forms provide onerous terms, such as unattainable notice requirements or provisions aimed at taking advantage of pay-if-paid clauses (where they are legal).

In the middle of the spectrum, some sureties lack the customer service skills to handle clients properly, while some subcontractors and other claimants make mistakes in the claims process, making it more difficult than it needs to be.

Everyone knows someone with a payment bond claim horror story because the outcome of each claim hinges on so many factors.

The process is prone to human error and, yes, manipulation. Business-savvy subcontractors know, however, that there are steps they can take to help them avoid common problems with payment bond claims.

One important step is to research the business environment in which the bond is being offered. What legal requirements exist to perfect a claim? What contractual requirements exist?

ASA's Lien & Bond Claims in the 50 States and the District of Columbia CD-ROM, and other publications, can help you conduct this research. (Order online at www.contractorsknowledgenetwork.org .)

The U.S. Treasury Department maintains a listing of sureties approved to do business with the federal government, which can be helpful in evaluating individual sureties. The listing can be found at www.fms.treas.gov/c570/index.html .

Another important step is to obtain a copy of the payment bond early and read it thoroughly.

On most public projects, subcontractors generally will be able to get copies of the appropriate bond forms from the contracting officer, if by no other means than by the assertion of a freedom of information act request under applicable law.

Under the federal Miller Act, subcontractors can obtain a copy of the bond from a contracting federal agency by submitting the appropriate affidavit. On private projects, subcontractors may have contractual rights to a copy of the bond affidavit.

The American Subcontractors Association (www.asaonline.com ) suggests looking especially at:

• Payment bond caps (Could the cap make the amount insufficient to pay your claim?)

• Who may file claims (Which tiers of contractors and suppliers?)

• What is covered (How about attorney fees in case of dispute?)

• The notice period (Who are the notice recipients; what is the start and length of the notice period; what are the permitted means of delivery?).

• Suit limitations period (When must suit be filed?).

Subcontractors will also want to limit their client's ability to invalidate the legitimate payment protections that are set forth in a payment bond.

Where pay-if-paid clauses are legal, courts sometimes allow these clauses to invalidate claims submitted by payment by the surety. Avoiding pay-if-paid clauses should remove these worries.

Some states allow the subcontractor to waive its bond rights, and others don't. The federal Miller Act permits subcontractors to waive their rights, but only after the subcontractor first provides labor or materials.

In all cases, consider limiting the scope of waivers to only that work for which your company has already received full payment.

Finally, subcontractors should consider modifying subcontract documents with language similar to model language developed by ASA. By conditioning bids, or negotiating the appropriate language, many problems can be avoided.

Additional information is available at the ASA web site at www.asaonline.com .