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Payment Bonds

Kellie M. Ros is an Associate at Peckar & Abramson, P.C.
Kellie M. Ros is an Associate at Peckar & Abramson, P.C.
A payment bond guarantees payment of subcontractors, laborers, and suppliers on a project. Payment bonds are required on public projects for prime contracts (the contract between the general contractor and governmental entity) greater than $25,000. But they are common on private projects as well, where they not only provide payment security but also protect the owner’s property from mechanic’s liens. If the project is bonded, a subcontractor/supplier should always acquire a copy of the bond before starting work or shipping materials.

On a private project, an unpaid subcontractor/supplier might lien the property in order to persevere its payment rights. However, some private owners may seek to protect their property from liens and require the contractor to acquire a payment bond. The payment bond creates an alternate source of funds for subcontractors/suppliers seeking recovery of progress payments. When a proper payment bond claim is made, a subcontractor/supplier may look to the surety to pay a debt unpaid by the contractor.

A payment bond on a private project must comply with Chapter 53 of the Texas Property Code and: be in the penal sum of the prime contract amount, be in favor or the property owner, be endorsed by the surety, property owner, and prime contractor, conditioned on prompt payment of all claims, and contain the surety’s contact information. The private project payment bond must also be recorded in the real property records, along with the prime contract, in order to validly prevent any mechanic’s lien filed against the property. If the prime contract is lengthy, a summary may be filed in its stead.

The best way for a subcontractor/supplier to perfect a claim against a private project payment bond is to follow all requirements for filing a lien against the project. The alternate method for perfecting a claim against the bond is by giving the notices which are required for a lien to the surety instead of the owner. A lien affidavit does not have to be filed in this case.

The time limit for filing suit for a payment bond claim under the Property Code is strict. A subcontractor/supplier must wait 60 days after it has perfected its claim to sue the contractor and surety (jointly or separately) on the bond. However, if suit on the bond is not made within one year after the claim is perfected, the claim is forever waived.

Unlike private projects, liens cannot be filed against public projects in Texas. This means that subcontractors/suppliers do not have the same protections in regard to their payment rights as they do on private projects. Public projects are governed by Chapter 2253 of the Texas Government Code. Chapter 2253 provides a substitute security by requiring a prime contractor to procure a payment bond in order to protect those same payment rights of subcontractors/suppliers. Just like on private projects, the bond must be in the amount of the prime contract.

A subcontractor/supplier must follow the notice requirements laid out under Chapter 2253 in order to protect a valid public payment bond claim. First-tier contractors (those hired by the prime contractor), must provide written notice, via certified or registered mail, to the prime contractor and the surety by the 15th day of the third month after each month in which work was performed or material delivered. This notice must also be accompanied by a sworn statement of account. Second-tier contractors (those hired by a subcontractor) must send two notices – the third-month notice as described above and a second-month notice. The second-month notice must be sent by the 15th day of the second month after each month in which work was performed or material delivered, but only needs to go to the prime contractor. Like a private project, a subcontractor/supplier must wait 60 days before filing suit on a claim. However, on a public project, the clock starts ticking and suit must be filed no later than a year after the date notice for a claim was mailed.

Once a payment bond claim is initiated, the surety investigates the claim in order to decide whether any action must be taken. This entails analyzing whether the subcontractor/supplier complied with the statutory notice requirements as well as determining whether the claim is in fact legitimate. If the claim is valid and the contractor cannot raise a legitimate defense to the claim, subcontractors/suppliers can expect to be compensated for their losses up to the full amount of the payment bond.

The surety will typically pressure the contractor to pay the claim or pay the claim itself. If payments are made by the surety, the contractor – or bond indemnitors – must reimburse the surety for their coverage of the payment bond claim. For that reason, contractors should always strive to avoid claims and seek solutions to problems before they escalate. Without a doubt, the payment bond claim process is an excellent opportunity for subcontractors/suppliers to gain leverage in negotiating a settlement.

On the flip side of the coin, it is sometimes difficult for a contractor to monitor the relationships of subcontractors and suppliers down the chain of contract and to ensure that payment issues do not arise. In order to protect its own interest, a prime contractor may require its subcontractor to provide a payment bond for the project. This offers another level of protection to contractors (aside from payment waivers and releases) and allows them to shift the risk of nonpayment to those further down the line. This type of payment bond (one made by someone other than the prime contractor) is not expressly governed by statute and is typically referred to as a common law bond.

Because these bonds and their terms are not subject to the usual statutory requirements, the wording of the bonds themselves is very important and must be strictly adhered to. And at a minimum, a prime contractor is well advised to keep an eye out for possible non-payment situations and quickly evaluate its subcontractors’ financial health.

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