Secrets of Bonding #12: This is NOT a Payment Bond!

 

Post #11 was about Payment Bonds – how they work and who they help.  Let go one step deeper. We will go over a Payment Bond situation that is presented to our underwriting department at least once a year, so it’s worth mentioning.

The Situation: A Prime Contractor or Subcontractor has a project that includes a major vendor. It could be an electrical contractor buying expensive switchgear from a supplier.  In this example the project is NOT bonded.

The supplier has no prior experience with the contractor so they want their purchase order (PO) covered with a Payment Bond. When you are asked to provide it, you immediately reply “Secrets of Bonding #12 tells me this is NOT a Payment bond!”

Let’s see why not, and how you can help your client.

In a normal contract surety Performance & Payment Bond scenario, the bond makes reference to a contract in which the Principal (bond applicant) is being PAID to do work.  If the principal fails in their obligation, the Surety steps in and is PAID the remainder of the contract funds to complete the obligation.

So, if a bond is written on a PO, which way is the money flowing?  In this instance, the principal (electrical contractor) is PAYING money, not receiving.

If the surety bonds the PO and then has a claim, it could only be for the contractor’s failure to pay the supplier. This bond has a single purpose, to guarantee the principals ability to pay money at a future date.  Therefore it is considered a Financial Guarantee, not a typical Payment Bond. This is a much less desirable obligation for the surety because the money is flowing the opposite direction.  Unlike contract surety, in the event of default there is no money coming in (the remainder of the contract price) to enable the surety to deal with the claim.  In fact, many sureties are reluctant to provide such bonds other than in nominal amounts for well-established clients (i.e. Wage and Welfare bonds).

A possible solution: Remember, this is an unbonded contract.   If there was a P&P bond in place, the purpose of the Payment bond would be to protect vendors such as the switchgear provider.  So one solution could be to issue a P&P bond for the electrical contractor even though none was originally required.  The Performance side of the obligation is not needed; however the Payment Bond would be furnished to the supplier to satisfy their concerns.  It will not name them specifically, but protecting them is clearly the purpose of the instrument.

In this manner you can turn an abnormal situation into a typical P&P bond, the kind underwriters like.  Added benefit: the Payment Bond will be for the entire contract amount – which is for more than the switchgear.  This gives some added comfort to the supplier.

KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating.  We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.

If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348

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