HANDLING SURETY PERFORMANCE BOND AND PAYMENT …
HANDLING SURETY PERFORMANCE BOND AND PAYMENT BOND CLAIMS
R. James Reynolds, Jr.
PHILADELPHIA OFFICE The Curtis Center 170 S. Independence Mall W. Suite 400E Philadelphia, PA 19106-3337 215-922-1100
PITTSBURGH OFFICE 525 William Penn Place Suite 3300 Pittsburgh, PA 15219 412-281-4256
WESTERN PA OFFICE 983 Third Street Beaver, PA 15009 724-774-6000
SCRANTON OFFICE 220 Penn Avenue Suite 305 Scranton, PA 18503 570-342-4231
MARGOLIS
EDELSTEIN
R. James Reynolds, Jr., Esquire (Harrisburg Office) 3510 Trindle Road Camp Hill, PA 17011 717-975-8114 FAX 717-975-8124
jreyn o ld s@ m arg o lised elstein .co m
CENTRAL PA OFFICE P.O. Box 628
Hollidaysburg, PA 16648 814-659-5064
SOUTH NEW JERSEY OFFICE 100 Century Parkway Suite 200
Mount Laurel, NJ 08054 856-727-6000
NORTH NEW JERSEY OFFICE Connell Corporate Center
Three Hundred Connell Drive Suite 6200
Berkeley Heights, NJ 07922 908-790-1401
DELAWARE OFFICE 750 Shipyard Drive Suite 102
Wilmington, DE 19801 302-888-1112
TABLE OF CONTENTS
I. Introduction II. Performance Bonds III. Payment Bonds
Page 1 2 20
I. Introduction
A. What is a surety bond?
1. A surety bond is a three-party agreement between the principal, the obligee, and the surety in which the surety agrees to uphold, for the benefit of the obligee, the contractual obligations of the principal if the principal fails to do so.
2. If the principal fulfills its contractual obligations, the surety's obligation is void. However, if the principal defaults on the underlying contract, the obligee can make a claim against the surety under the surety bond.
3. Suretyship is distinguishable from insurance. Suretyship is not a form of insurance. The suretyship relationship is a three-party relationship (surety, principal and obligee). In an insurance contract, there are only two parties (insurer and insured).
4. In an insurance relationship, the insurer undertakes to indemnify the insured against loss as a result of an unknown or contingent event. In a suretyship relationship, the surety undertakes to answer for the debt or default of the principal.
B. Who are the three parties to a surety bond?
1. Principal - the principal is the primary obligor who performs the contractual obligations (e.g. the contractor on a construction project).
2. Obligee - the obligee is the entity that enters into the contract with the principal and is the recipient of the obligations (e.g. the governmental unit on a construction project).
3. Surety - the surety is the secondary obligor which guarantees that the principal's obligations will be performed.
C. What are the types of surety bonds?
There are two main types:
1. Contract Surety Bonds - They guarantee a specific contract and include: (a) performance bonds (discussed in Section II below); (b) payment bonds (discussed in Section III below); and (c) bid bonds.
2. Commercial Surety Bonds - They guarantee the terms of the bond, rather then a specific contract, and include: (a) license and permit bonds (e.g. motor vehicle dealer bonds; (b) notary bonds; and (c) other types of miscellaneous bonds- public official bonds, fuel tax bonds, etc.
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D. What is the penal sum of the surety bond?
1. The penal sum is the maximum amount set forth in the bond which the surety will be required to pay in the event of the principal's default.
2. Generally, the penal sum is the amount of the contract entered into between the principal and the obligee.
E. What are the surety's rights of indemnity?
1. In consideration for issuing bonds on behalf of the principal, the surety will generally require the principal, individuals with an ownership interest in the principal entity (and their spouses), and related entities to execute an Indemnity Agreement in favor of the surety which, among other things, requires the indemnitors to indemnify/reimburse the surety for all losses and expenses (including attorney's fees, consultant's fees, and court costs) that the surety incurs as a result of issuing the bonds.
2. If the surety pays a claim under a surety bond, it can seek indemnification/reimbursement from the principal and the indemnitors who have signed an Indemnity Agreement in favor of the surety.
II. Performance Bonds
A. Purpose of performance bonds
1. A performance bond protects the owner against the risk of default on a construction contract.
2. A performance bond provides available funds to complete the principal's contract should the principal be in default of the performance that is owed to the obligee.
3. The surety's obligation tracks that of the principal under the bonded contract up to the penal sum of the bond, subject to the specific terms and limitations in the bond, and is conditioned upon the principal's material default of its performance obligations under the bonded contract.
B. Parties to performance bonds
1. There are three parties: the principal (typically the general contractor) who has assumed a contractual undertaking; the obligee (typically the project owner) who is entitled to the benefits of the principal's performance; and the surety who provides a performance bond that secondarily guarantees to the obligee performance of the principal's contractual undertaking.
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2. If the surety pays an obligee under the performance bond, it is entitled to be indemnified for its loss pursuant to a written indemnity agreement, which is part of the consideration for issuing the bond.
C. Types of performance bonds
1. Federal Miller Act Bonds
(a) Before any contract of more than $100,000 is awarded for the construction, alteration or repair of any public building or public work of the federal government, a performance bond must be furnished. 40 U.S.C. ? 3131(b)(1).
(b) The performance bond shall be in an amount the contracting officer considers to be adequate for the protection of the Government, including coverage for taxes. 40 U.S.C. ? 3131(b)(1).
(c) The Miller Act does not prescribe the form of the required performance bond, but the Code of Federal Regulations provides a standard form, Federal Standard Form 25 Performance Bond, that is commonly used.
2. State Public Works (Little Miller Act) Bonds
(a) All states have public work statutes that require contractors that are awarded contracts on state public projects to provide performance bonds.
(b) These statutes are often referred to as "Little Miller Acts," since most of them contain provisions that are similar to the Miller Act.
3. Pennsylvania Little Miller Act Bonds
(a) The statutory bonding requirements for Pennsylvania public works projects are set forth in the Pennsylvania Public Works Contractors' Bond Law of 1967, 8 P.S. ?? 191 et seq. ("PA Bond Law") and in Part I of the Commonwealth Procurement Code, 62 Pa. C.S.A. ?? 101 et seq. ("PA Procurement Code"), which was enacted in 1998.
(b) Prior to the adoption of the PA Procurement Code in 1998, the PA Bond Law was the controlling statute with regard to bond requirements for all public bodies in Pennsylvania.
(c) As a result of the enactment of the PA Procurement Code, the PA Bond Law only applies to public projects that are not with Commonwealth purchasing agencies (e.g. municipalities, school districts, municipal authorities, etc.). The PA Procurement Code applies to public contracts with a Commonwealth purchasing agency.
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