Payment Bonds. Bonds For the Not So Criminally Inclined

by Wendel, Rosen, Black & Dean LLP
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Get out of jail free cardI’m going to venture a guess that most of the readers of the California Construction Law Blog have not spent time in jail (or, at least, not much time there). And that when they think of bonds the first thing they think of is Bad Boy Bail Bonds, Bulldog Bail Bonds or some other colorful name which includes the word “bonds” and is associated with those of us who are less than law abiding . . . like Barry Bonds.

But the bonds I’m talking about are payment bonds, and they work in pretty much the same way, sans criminal charges.

What is a payment bond?

A payment bond is a promise by one party (the surety) to pay a third-party (the obligee) an obligation owed by another party (the principal).

Or, to put it another way, a payment bond is a type of bond issued by a surety on behalf of a principal, such as a direct contractor, which guarantees the principal’s payment obligations to an obligee, such as a subcontractor or material supplier, for work performed or materials provided by the obligee.

Like an insurance policy, a premium is paid by a principal to a surety company to obtain a payment bond. Premiums are typically 1 to 5% of the bond amount. However, unlike an insurance policy, if a surety has to pay out on a payment bond to an obligee, the principal has to reimburse the surety for the full amount the surety had to pay out on the payment bond to the obligee. To help ensure they are paid back, most surety companies require that a payment bond be personally guaranteed by a credit worthy owner of the principal.

On what types of projects is a payment bond required?

On federal projects, direct contractors are required to furnish payment bonds for federal construction contracts in excess of $100,000.

On California public works projects, direct contractors are required to furnish payment bonds for public works contracts in excess of $25,000.

In all other cases, whether a payment bond is required is up to the agreement of the parties.

Note: When a direct contractor is required to furnish a payment bond, direct contractors often include a “flow-down” provision in their subcontracts with their subcontractors requiring that their subcontractors furnish payment bonds for their subcontract work.

Who can make a claim on a payment bond?

Subcontractors and material suppliers under contract with the direct contractor or second-tier subcontractors or second-tier material suppliers of a subcontractor under contract with a direct contractor can make an claim on a payment bond. Notice this subtle but important distinction. Thus, second-tier subcontractors or second-tier material suppliers of a material supplier under contract with a direct contractor are not entitled to bring such claims.

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Do I need to serve a preliminary notice in order to make a claim on a payment bond?

Yes, and oddly, no. Yes, on private projects, you are supposed to serve a preliminary notice in order to make a claim on a payment bond if you are a first- or second-tier subcontractor or material supplier. In addition, on public projects, you are supposed to serve a preliminary notice in order to make a claim on a payment bond if you are a second-tier subcontractor or material supplier of a first-tier subcontractor.

Note: A preliminary notice is not required to be served if the work to be furnished has a value of $400 or less. Likewise, laborers are not required to serve a preliminary notice.

However, there is an exception A payment bond claimant may still make a claim against a payment bond even though it failed to serve a preliminary notice if the claimant: (1) gives written notice to the surety and principal within 15 days after recordation of a notice of completion; or (2) if no notice of completion is recorded, gives written notice to the surety and principal within 75 days after completion of the work of improvement.

What information do you need to make a claim on a payment bond?

California law does not specify what information must be included in a payment bond claim. In fact, other than giving notice of a claim when a preliminary notice was required to be served but was not, California law does not provide that a payment bond claimant has to tender a claim at all. Nevertheless, I believe it is a good practice to do so, because the alternative is to proceed directly to filing a lawsuit which can be expensive and time consuming.

At a minimum, I suggest sending the principal and surety a payment bond claim by certified mail which includes the following:

  • The bond number;
  • The name of the project and location;
  • The name of the owner or reputed owner;
  • The name of the party by whom the payment bond claimant was employed or to whom the payment bond claimant furnished work;
  • A description of the work furnished by the payment bond claimant;
  • A description and itemization of the payment bond claim; and
  • Copies of all documents supporting the payment bond claim.

Is there a deadline to bring an action to enforce a claim on a payment bond?

Yes. However, the deadline to file a lawsuit to enforce a claim on a payment bond depends on whether the claim is being made on a payment bond on a public works project or private works project.

  • Public Works Projects: After the payment bond claimant ceases to furnish work, but no later than the earlier of 6 months following:

(1) 90 days after completion of the project; or

(2) 30 days after the owner records a notice of completion or cessation.

  • Private Works Projects: No later than the earlier of:

(1) 4 years if the payment bond was not recorded; or

(2) 6 months if the payment bond was recorded.

Note: You should get a copy of the payment bond because sureties can shorten the deadline in which a payment bond claimant has to make a claim on a payment bond. The only restriction is that sureties are not allowed to reduce the period to less than 6 months. Therefore, just because a payment bond was not recorded, does not necessarily mean that you have 4 years to bring an action to enforce a payment bond claim.

Are attorney’s fees recoverable in a lawsuit to seeking to enforce a claim on a payment bond?

It depends. Reasonable attorney’s fees are recoverable when enforcing a payment bond claim on a public works project. However, on private works projects, whether attorney’s fees are recoverable, depends on the terms of the bond.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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