Tuesday, April 16, 2013

Is a Contract Bond Different From a Payment and Performance Bond?

When public agencies contract with a construction contractor, they typically are required to obtain a bond or bonds issued by a surety.  Bonds often have different names.  The important thing is that the bond or bonds submitted provide the appropriate protections.

Performance protection:  A public agency is most concerned that they obtain a bond that protects the agency to ensure that the contractor successfully and faithfully performs and finishes the work that is the subject of the contract.  Here is typical language from a bond that describes the obligation of the surety in which they guaranty the performance of the contractor:
This statutory performance bond shall become null and void, if and when the Principal, its heirs, executors, administrators, successors, or assigns shall well and faithfully perform all of the Principal’s obligations under the Contract and fulfill all the terms and conditions of all duly authorized modifications, additions, and changes to said Contract that may hereafter be made, at the time and in the manner therein specified; and if such performance obligations have not been fulfilled, this bond shall remain in full force and effect.
Payment protection:  Public agencies are also often required to obtain a bond that provides for payment protection, in which the bonding company guaranties that the contractor will pay all of their subcontractors, suppliers, and workers.  If the contractor fails to do so, the surety agrees they will pay.  Here is typical language from a bond (from Washington state) that describes the obligation of the surety for payment:
This statutory payment bond shall become null and void, if and when the Principal, its heirs, executors, administrators, successors, or assigns shall pay all persons in accordance with RCW Titles 39.08 and 39.12 including all workers, laborers, mechanics, subcontractors, and materialmen, and all persons who shall supply such contractor or subcontractor with provisions and supplies for the carrying on of such work; and if such payment obligations have not been fulfilled, this bond shall remain in full force and effect.
Bond names:  In evaluating a bond, there may be one bond that provides both performance and payment protections.  Read the language of the bond carefully to ensure that it provides protection for both performance and payment.  These combined bonds may have a variety of names (Contract Bond or Performance and Payment Bond).  What it is called is less important than if it provides the required protections.  On the other hand, the bonding protection may be in the form of separate bonds in which the contractor is required to submit a separate Performance Bond and a separate Payment Bond (sometimes called a Labor and Material Payment Bond). 

Obtain separate bonds:  Public agencies receive more protection if they obtain separate Performance and Payment Bonds, each in the amount of 100% of the awarded contract amount.  I've previously blogged on this subject.  Click here to read my previous blog entry on the subject.

Standard agency bond forms:  Because language in performance and payment bonds may vary, and may or may not provide the required protections, it is a good practice for public agencies to work with their attorneys to adopt their own performance and payment bonds that sureties and contractors are required to use.
Mike Purdy's Public Contracting Blog 
© 2013 by Michael E. Purdy Associates, LLC 


Anonymous said...

Is a surety required to publicly bid work needed to complete from its defaulted contractor? Is there a regulation for this?

Mike Purdy said...

It's a great question. I'm not aware of any regulation that specifically addresses this issue. My sense is that the surety would not be required to publicly bid work needing to be completed from its contractor that defaulted on the project. My reasoning is that the surety steps into the shoes of the contractor and is the party at risk financially for completing the work up to the dollar amount of the Performance Bond. Because the surety is at risk, they should be able to complete the project through whatever methods they choose. In one sense, you can argue that the surety is simply an extension of the contractor and the contract has, in essence, been assigned to the surety.

Jean McCartney said...

What is the difference between payment/performance bonds and warranty/maintenance bonds? We have a non-profit owner asking for all four bonds on one project!

Mike Purdy said...

Jean, A payment bond provides protection by the surety that the contractor will pay all subcontractors, suppliers, and workers. A performance bond provides protection by the surety to the owner that the contractor will successfully perform and finish the work of the project. While there may be a distinction, my understanding is that a warranty and maintenance bond provide the same protection. Generally, a payment bond and performance bond cover all of the terms and conditions of the contract, and that includes payment and performance provisions during what is typically a one year warranty period, during which the owner may require the contractor to come back and fix items. A warranty or maintenance bond would be required when the warranty period in the contract is longer than one or two years, which is typically the maximum protection afforded by the payment and performance bonds. Thus, a warranty or maintenance bond would provide both payment protection to subcontractors, suppliers, and workers, and performance protection to the owner that the contractor would successfully perform during a longer than one or two year warranty period. Regarding the non-profit requesting four bonds, it is entirely reasonable that both the payment and performance bonds would be required. You would need to look at the terms of the contract to see what the length of the warranty period is. If it is only one year (or maybe two years), there should be no need for them requiring the warranty/maintenance bond. If the warranty period is for longer than one or two years, requiring the warranty/maintenance bond would be reasonable, but I think this is one bond, not a separate warranty and separate maintenance bond. I hope this explanation is of assistance to you. Please feel free to contact me again through the blog or directly if you have further questions or would like to discuss this more.

Anonymous said...

A principal has asked for my city to return a void performance bond. The bond is void because the principal completed the project over a year ago. The principal claims the void performance bond “ties up” its credit. Can this be true? Must I return a void bond? Thank you for your time.

Mike Purdy said...

I don't think it's necessary (or a good idea) to return a performance (or payment) bond to the principal (contractor). By the very language of the bond, the bond becomes void if the principal successfully performs all the work of the contract. As a matter of public record, you would want to keep the bond as evidence for an auditor that you complied with the requirement to obtain the bond. If the contractor is concerned that their bonding capacity is being tied up, you could suggest that they simply provide a copy of your notice of final acceptance of the project to the bonding company, or you could write a letter to the contractor notifying them that all the obligations of the bond have been satisfied. If you write such a letter, make sure that you are not still within the warranty period of the project, usually one year after substantial completion. The bond should remain in effect through the end of the warranty period in the event issues arise during this period. I hope these comments address your question. Please let me know if you have further questions.