Secret #87: Payment Bonds – You Like It Hard or Easy?

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If you like to do things the hard way, stop reading. You’ll hate this article.

On unbonded construction projects, it is not uncommon for high dollar vendors to specifically ask for the protection of a Payment bond. When this is presented to surety underwriters, they quickly recognize that the purchase order is the subject of the bond guarantee, not the construction contract. This is a much more difficult underwriting scenario.  Why?

When a Performance and Payment Bond (P&P bond) is written on a project, the principal (contractor) is being paid to perform the work. If they fail and the surety is called in to complete the job, the unpaid balance of the contract price is a financial resource that remains available. Even if the principal has no financial capabilities, the surety still has a source of money that may be adequate to complete the obligation without having to add funds.

easy-hard

Now let’s go back to the vendor scenario. We are assuming there is no P&P bond on the project. When the vendor demands the protection of a payment bond, it will be a guarantee of the purchase order not the construction contract. It is purely a guarantee that the principal will pay the vendor. It is not a promise that incoming contract funds will be used appropriately to pay bills. Big difference!

The point is that in the vendor example, it is considered a financial guarantee – a promise that the principal will pay money when appropriate. The reason these obligations are more difficult may be obvious. If the customer is unable to pay the vendor because they’re out of money, only the surety remains to pay the bill. Solving the bond need of the vendor by issuing a financial guarantee bond on the purchase order is the hard way to solve this problem.

The Easy Way
If a 100% performance and payment bond had been required on the contract, it would have guaranteed (among other things) the payment of all bills for labor and material, including the one in question. Even if the project owner did not stipulate a P&P bond, it does not mean one cannot be used to solve the problem.

The easy solution, the alternative we always suggest, is to order a traditional 100% P&P bond and then simply file a copy of the payment bond with the vendor. It does not name the vendor as obligee the way a financial guarantee bond would. However, it is issued literally for the protection of such vendors and solves the need perfectly, and with less underwriting stress and probably a lower premium!

This can be a great solution that converts very challenging underwriting into plain vanilla.

Consider using this technique when the purchase order is a major portion of the overall contract. If it is not, it may not be economical to bond the entire job, just to cover one vendor. Then it could be necessary to pursue the financial guarantee bond instead.

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