Labour & Material Payment Bonds
A labour and material payment bond guarantees that the bonded contractor will pay all claimants for goods and/or services supplied for the bonded project. A claimant under a labour and material payment bond is a trade contractor or supplier who has a direct contract with the bonded contractor to supply goods or services to the bonded job. Lower tier subs or suppliers are not protected under the standard labour and material payment bond. It’s very important to note that a payment bond is a companion document to the performance bond and the two should be executed together. Bonding companies typically will NOT issue a payment bond as a “stand alone” obligation. Like performance bonds, owners typically ask for 50% of the contract amount, but labour and material payment bonds can also be in the amount of 100%. The surety can never be liable for more than the total amount of the bond.
Although an owner is named as a “trustee” under the bond, this is only for administrative purposes and does not mean the owner is obliged to act on a claimant’s behalf. Claimants can claim against the bond directly.
Timing is everything when it comes to payment bonds. In order to make a valid claim, it must be submitted before the expiration of 120 days from the last day the claimant worked on the project or furnished materials to the project. With respect to holdback amounts, a claim must be made before the expiration of 120 days from the day on which the claimant should have been paid in full under the contract. The bond amount applies to all claims from all claimants. Any litigation or action under the bond must be initiated before one year from the time that the bonded contractor ceased work on the bonded project.
Understanding Labour & Material Payment Bonds
While the owner is not a claimant under the bond and therefore does not derive any financial benefit, the owner does have a moral, legal and often political obligation (in the case of a public sector owner) to make sure all trades on their projects are paid in full.
Eases Administrative Burden
Should a default occur on a major construction project without a payment bond in place, owners may find themselves inundated with phone calls from unpaid subtrades and suppliers demanding payment for work done or materials provided. With a bond in place, the surety takes over thus greatly reducing the administrative burden for the owner.
Reduces Owner’s Legal Exposure
In most jurisdictions in Canada, owners are required by law to hold back 10% from each draw as a reserve against liens posted by trades and suppliers. If a general contractor defaults leaving a trail of liens and unpaid bills, the owner is responsible for distributing these holdback monies among valid lien claimants. By paying outstanding bills to direct trades, a payment bond will largely alleviate lien problems and allow money to flow in a normal manner.
More Competitive Prices
Sophisticated trades and suppliers know which owners call for payment bonds which translates into more competitive prices for the owners. Trades and suppliers know their credit risk is secured by a payment bond which typically translates into a “discount” which is passed along to the owner.
Continuity of Project Team
If a general contractor defaults and no payment bond is in place, unpaid trades and suppliers have little incentive to work with the surety and completing contractor. With a bond in place, there is incentive for the existing team to keep working which allows for a faster and smoother resolution.