Breaking Bonds Down: What You Need to Know to Protect Your Business

By Karalynn Cromeens

Generally speaking, bonds are required on any public project, whether federal or state. Depending on your state’s laws or the project owner, they may be required on private projects and usually are required in a pair: payment and performance bonds. Although commonly referred to singularly as a “payment and performance bond,” they are different and protect the owner or general contractor from two different situations. Before diving into the two distinct types of bonds, it is important to note what a bond is not.

A Bond is Not Insurance

Repeat after me: a bond is not insurance! Instead, a bond is a guarantee to a party of your performance under the contract. This means that if you default on your obligations under the contract, the bond company will pay either the owner or the general contractor to complete your performance. If a bond company is required to pay even a penny to someone, you owe the bond company the money they paid out to cover your default. If you’ve ever had to get a bond, you likely know that you must sign a personal guarantee and pledge all your personal assets to get the bond. If you default and the bond company pays out, they will come after all of those assets to pay back any amount they paid out. The bottom line is that a bond is a personal guarantee of your performance under a contract, so proceed accordingly.

A Bond Breakdown

A payment bond guarantees that you will pay all your material suppliers, subcontractors and anyone else who works on the project to whom you may owe money. If you fail to pay someone, they can file a claim on your bond for payment. Additionally, if the general contractor or owner notices that someone who worked for you is unpaid, they can file a claim on your bond for payment. A performance bond guarantees that you will complete the work required by the contract you signed. This means that if you are in default or are terminated, whoever hired you and required you to obtain a bond can file on the bond for the cost required to complete your work.

Be Proactive and Preventative

If someone files a claim on your bond, don’t ignore it in the stack of paperwork you signed with the bond company. You have given them authority to pay claims. That means, even if you disagree with the claim made, they can pay it anyway and in whatever ways they deem necessary.

How can you build in some protection if you must get a bond? Here are some tips that can help if you are required to get a bond. First, if you’re a subcontractor, make sure you get a copy of the general contractor’s bond before you sign the subcontract. This allows you to make a claim on the general contractor’s bond for the amount you’re owed. This will protect you from claims on your bond when the general contractor has not paid you. Next, add some language to your subcontract that gives you a chance to dispute any bond claim before the bond company pays out funds. Finally, always respond immediately to any claim filed against your bond and demand that the bond company not pay the claim. Send this notice to both the company that filed the claim and the bond company.

Because you cannot file a lien on public property and can file a bond claim instead, bonds are a necessary part of the construction industry. Make sure to go into any project that requires you to obtain a bond with your eyes wide open. Stay attentive, and you’ll be fine.

Karalynn Cromeens is the owner of The Cromeens Law Firm and The Subcontractor Institute in Houston. She has been a licensed construction attorney for over 16 years.

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