Defending a bond claim: What to look out for
Thursday, February 02, 2017
In order to discuss the appropriate ways in which to defend against a bond claim in any meaningful way, some background should be provided regarding what payment bonds are, and how they work. While there are multiple types of bond in the realm of construction — bid bonds, performance bonds and payment bonds to name three — the focus of this article will stick to payment bonds.
"A payment bond is a surety bond posted by a contractor to guarantee that his subcontractors and material suppliers on the project will be paid," according to the Business Dictionary.
While one could probably construct a more precise legal definition, the concept behind a payment bond is clear. Payment bonds are obtained to ensure that subs and suppliers are paid for the labor or material furnished to a construction project.
Payment bonds are mandated on certain public projects and may be obtained on private projects at the desire of the property owner or GC. While the floor for total contract value that mandates a bond on a public project varies by state, as a practical matter most substantial public works projects will have a payment bond obtained from a surety by the direct contractor.
Since there are specific requirements that many public projects be bonded, payment bonds are most often found on public works projects, whether those projects are federal, state or municipal. However, this does not mean that payment bonds are entirely foreign to private construction projects. Payment bonds can be desired by the owner or GC on a private project as a matter of contract to protect the property from liens, or may be obtained subsequent to a lien filing to "bond off" the lien at issue.
In a nutshell, a payment bond provides a similar security to a mechanics lien, just that the claim is made against the bond provided for that purpose rather than against the property itself. If subcontractors, suppliers or other lower-tiered parties are not paid, the bond provides a type of security against which they can make their claim for payment.
How do payment bonds work?
As noted above, a payment bond claim is analogous to a mechanics lien claim, just that the claim is made against a different collateral. Where a mechanics lien secures a debt through an interest in the underlying property itself, a bond claim provides a remedy to collect from a "pool of money" established and provided for that purpose.
The bond — which is generally required to be an amount sufficient to pay the claims of all lower-tiered parties — provides a "fund" against which unpaid parties may make a claim, and ultimately get paid.
Just like the remedy, the process of making a claim against a payment bond also has similarities to a mechanics lien claim. Notice is generally required prior to making the claim, and then a notice of the claim itself must be provided. The main difference in a bond claim is that the claim is rarely required to be recorded in the land records, as a mechanics lien would be.
Because of the similarities, bond claimants can be subject to the same common mistakes that plague mechanics lien claimants: failing to provide required notices, failing to meet required deadlines, failing to provide required information or use a proper form, and more.
Once the required preliminary notices have been sent and the bond claim in made, it is likely that the surety will require the claimant to provide more information and supporting documents, upon receipt and review of which the claim will either be paid or denied. Just like there are set deadlines by which a bond claim must be made, there are also set deadlines by which a bond claim must be enforced.
Similar to mechanics liens, a bond claim will be extinguished after a certain amount of time passes. If the deadline to enforce passes, the claimant will no longer have a right of action against the bond to recover payment.
Common mistakes to Avoid: Defending a bond claim
Just like claimants occasionally file improper mechanics liens, a claimant may also assert an improper claim against a bond. Since no party providing a bond wants to deal with navigating a claim against it, it is important to make sure the response is efficient and accurate to avoid a drawn-out process.
Preliminary notice requirements work in favor of the party defending a bond claim — if the requirements are not met, the claim may be invalid; if the requirements are met, the provided notices should provide useful information about the parties on the project and their potential claim amounts. The fact that the defending party doesn’t need to give the notices is not an excuse to be ignorant of the notice’s specific requirements.
If notice is required and not received within the mandated time period, defending any subsequent claim against the bond becomes that much easier. If a bond claim is made, the information that no required notice was provided can be given to the surety at the same time it is notified of the claim.
For a party defending a bond claim, the same considerations given to preliminary notice should be given to the claim itself. Failure of the bond claimant to comply with the specific rules can invalidate the claim. If the bonded contractor is aware of the rules, it is in a much better position to defend itself than a contractor that is unaware of those rules.
Bond claim defenders should also make it routine practice to retain information that would be beneficial in the event a claim is made, like information or documents related to whether the work was performed, whether payments were made, etc. Just like the surety will request additional information and support from the claimant, additional information and support will be required from the prime contractor, as well.
Having the information handy, and providing it quickly, will be beneficial. Sureties will generally stick with the bonded contractor’s arguments if they are well documented, and well organized. Providing information supporting the position that payment is not necessary can increase the likelihood of success.
Also, it is too common for prime contractors to wait to provide the surety with notice that the claim has been made, if the claim was not provided directly to the surety by the claimant. This is not a good idea. Sitting on a bond claim and not providing it to the surety can strain the relationship, and the requirements of the bond will generally specifically require the prime contractor to notify the surety of any bond claim within a certain time period.
Failure to do so can provide the surety with a defense to paying the claim — which means that 100 percent of the liability (and, potentially, the legal costs of the surety) will be passed on to the prime contractor. This can be avoided simply by passing the claim along when received.
It is also important to note that if there is any undisputed portion of the claim, that portion should be paid. Failure to pay even when the right to payment is undisputed can open a company up to much more exposure than originally bargained for.
By keeping these common mistakes in mind so they can be avoided, a bond claim defender is more likely to succeed in the defense.
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