The term “bond” can be confusing, because it has so many different meanings in various commercial contexts. A municipal bond or a corporate bond is an evidence of a debt and an investment for the person who buys it. A jail bond is provided as security to assure that a criminal defendant will appear at a later trial. All bonds, however, involve either a promise to pay or a promise to perform some sort of contractual obligation.

A bond posted pursuant to a construction contract is security to assure performance of the contract obligations. When a real estate owner desires to construct an office building, the owner may wish to have security that the general contractor will fulfill its obligations to complete the project and pay all subcontractors.

If the general contractor is a corporation, the real estate owner could require a personal guaranty from its president and sole shareholder. The individual shareholder of the general contractor corporation would be the “surety” on this bond. Additionally, the owner may wish to have security from outside the general contractor corporation. This would be a “third party” bond, the most common type of bond used in construction contracts.

Surety

A “surety” provides a bond. The surety could be a wealthy individual (“private surety”), but it is more likely that the surety will be a large company in the business of providing surety bonds (“corporate surety”). Insurance companies are often corporate sureties.

Most sureties charge a “premium” for providing a bond. If a bond is provided for free (by a friend or family member), the provider is an “accommodation surety.”

Principal, Obligee and Obligor

The “principal” performs the construction contract and is the “primary obligor,” the person primarily obligated to complete the contract. The surety has no obligation unless the principal fails to fulfill the contract obligations.

An “obligee” is the person who requires a bond. A real estate owner who requires a bond from the general contractor is an obligee. Likewise, a general contractor who requires a bond from a subcontractor is an obligee under the subcontractor bond. The obligations under the bond run primarily to the obligee.

To summarize, the principal enters into the construction contract with the obligee. The principal finds the surety and pays any premium. If the principal fulfills its contract obligations, the surety’s obligation is void. However, if the principal defaults on the construction contract, the obligee can make a claim against either the principal or the surety.

Beneficiary

The “beneficiary” is the person intended to benefit from the bond and is the person with the right to sue under the bond. In a performance bond, the owner will be the beneficiary. If the bond principal does not complete the contract, the owner can sue under the performance bond. In this case the beneficiary is also the obligee.

Sometimes, the beneficiary is not a party to the bond at all. In a payment bond, the beneficiaries are all subcontractors and suppliers providing labor or materials to the bond principal. These people are not parties to the bond, are not obligees and may not even know that the bond exists. They are “third-party beneficiaries.”

Types of Bonds

Payment Bond

In the payment bond, the surety provides security that all persons supplying labor and material to the project will be paid. Subcontractors and suppliers are the “beneficiaries” of a payment bond. They do not require the bond. They are not parties to the bond but are third-party beneficiaries. However, the payment bond ensures that subcontractors and suppliers will be paid so that the obligee will not be held responsible for payments due if the principal fails to pay. If the principal defaults, beneficiary subcontractors and suppliers usually have the right to sue the surety directly for payment.

Performance Bond

In a performance bond, the surety provides security that the principal will perform all of its contract obligations in a timely and workmanlike manner.

Usually, a performance bond is only for the benefit of the obligee/owner of the construction project. If the principal defaults, the obligee/owner can require the surety to complete the project or to pay for the costs of completion. Subcontractors do not have the right to seek payment from the performance bond surety if the principal defaults.

A general contractor can require a subcontractor to obtain a performance bond as security that the subcontract will be completed in a timely and workmanlike manner. In this case, only the obligee/general contractor can require the surety to complete the subcontract work or to pay for the costs of completing the subcontract work.

Bid Bond

A bid bond provides security to the obligee/owner that if a contract bid is awarded to the principal, the obligee/owner will have the work completed at that bid price. If the principal fails or refuses to enter into a contract for the bid price or to provide any required performance and payment bonds, the surety will be responsible for any costs incurred in rebidding the project and any increased contract costs. An owner can require bid bonds from all general contractors bidding on a project. A general contractor can also require bid bonds from all subcontractors bidding to the obligee/general contractor.

Mechanic’s Lien Bond

A mechanic’s lien bond is usually provided in connection with a court proceeding by a real estate owner or a general contractor to “bond off” a mechanic’s lien. A real estate owner or a general contractor can remove a mechanic’s lien from the land records by “bonding it off.” The surety promises to pay the mechanic’s lien claimant if the mechanic’s lien is later proven to be valid. The mechanic’s lien claimant is thus provided alternative security for the claim. The claimant no longer has the right to go against the real estate to obtain payment, but can now go against the bond instead. This is discussed in greater detail in the chapters on Mechanics’ Liens above.

BONDS ON PUBLIC PROJECTS—THE FEDERAL MILLER ACT

40 U.S.C.A. Section 3131, et seq., commonly referred to as the federal “Miller Act,” is the grandfather of all public project-bonding statutes. The Miller Act requires performance and payment bonds for the “construction, alteration, or repair of any public building or public work of the United States.”1

Most states have similar laws for state and municipal projects. These state laws are similar to the federal Miller Act and are referred to as “Little Miller Act” statutes. The Miller Act was first enacted in 1935, and federal courts have provided much guidance on its interpretation. State courts interpreting their own Little Miller Acts will often look to federal case law for guidance.

State bond principals and claimants should remember, however, that the Little Miller Acts in each state vary slightly and those state courts are not required to follow federal courts. It is dangerous to think you know the bond laws in Virginia because you have experience in Maryland or with federal projects. Nonetheless, the federal Miller Act is a good starting point for a discussion of public bonding law. This chapter will discuss the federal Miller Act, followed by a discussion of the Little Miller Acts of Virginia, Maryland, Pennsylvania and the District of Columbia, focusing on their differences with the federal Miller Act.

Miller Act Payment Bonds

Introduction

Contractors cannot file mechanics’ liens on public projects such as highways, schools, fire stations, etc. Enforcement of such a mechanic’s lien would result in the foreclosure of public real estate. Instead, contractors and suppliers on public projects are provided alternative security. A general contractor on a public project usually must provide a payment bond to secure payment to all subcontractors and suppliers on the project. The general contractor is the principal on the bond. The third party surety guarantees that qualified claimants will be paid.

Payment bonds are required for any contract for the alteration or repair of any public building or public work of the United States that is for an amount greater than $100,000.2 The payment bond must be equal to the total amount due under the contract.3 For any contract for the alteration of any public building or public work or the United States that is for an amount greater than $25,000, but less than $100,000 an alternative form of security must be provided for the protection of subcontractors and materials suppliers.4 The contracting officer on such projects must select two or more acceptable forms of alternative security, from which the contractor may choose.5 Several alternative forms of security include: a payment bond, an irrevocable letter of credit, a tripartite escrow agreement, or a certificate of deposit.6

Possible Bond Claimants

Miller Act payment bonds are for “the protection of all persons supplying labor and material in the prosecution of the work.”7 There are two main questions in determining who may make a claim (who is a beneficiary under the bond): (1) whether the claimant supplied a type of labor or material that is covered, and (2) whether the claimant is too remote contractually from the bond principal.

First, the claim must be for labor and material in the prosecution of the work. This generally means that traditional subs on the project such as electrical, masonry, etc. are covered. There are gray areas, however. Any contractor needs paper, pencils, and office staff to perform work. In a sense, such labor and materials are figured into the contractor’s bid and are a part of the project. Office staff cannot make bond claims for labor, however, nor can stationary stores make claims for materials because they have not supplied labor and material in the prosecution of the work.

A common problem involves architects, engineers, estimators and other professionals. These professionals will not have a claim unless they have a physical presence and duties on the job site.8

Second, the federal courts decided long ago that the bond covers only “first tier” claimants, persons dealing directly with the prime contractor, or “second tier” claimants, persons supplying labor or materials to a subcontractor of the prime. This means that bond rights go only so many links down the chain from the prime. This is graphically described by the chart on the next page.

First tier claimants deal directly with the prime contractor. They are covered as long as they supplied labor or material used “in the prosecution of the work.”

Second tier claimants are covered if they have dealt with a subcontractor and supplied labor or material used “in the prosecution of the work.” This means a subcontractor must “take over” and perform a specific or recognizable portion of the prime contract.

The most common problem arises with materialmen (suppliers). Federal courts interpreting the Miller Act have decided that materialmen are not subcontractors (a subcontractor supplies labor and materials). Materialmen have not taken over a “specific or recognizable portion of the prime contract” because they have provided no labor. They are “mere materialmen.”9

The courts have recognized two levels of materialmen. First tier materialmen supply materials to a subcontractor or to the prime. Second tier materialmen do not supply a subcontractor but supply only other materialmen. First tier materialmen are covered.10 Second tier materialmen are not protected by Miller Act bonds.10 Second tier materialmen are not protected by Miller Act bonds.11 In other words, a “supplier to a supplier” will not have bond rights.

Potential bond claimants, evaluating their security before supplying labor or materials to a project, should determine how far removed they are from the bond principal. A general contractor/bond principal can create related corporations that will act as subcontractors on a job. These “related subcontractors” could then contract with outside companies for labor and materials. There may be legitimate business reasons for creating these intervening related entities, but potential claimants should understand that they are now further removed from the bond principal and may not have any bond rights.12 Courts can refuse to recognize “straw man” subcontractors. The court can look to the substance of the transaction instead of the form to hold that the claimant is dealing directly with the prime. This can save bond rights when dealing with such related intervening contractors.13

Possible Bond Claims—Compensable Costs

Labor

Since Miller Act payment bonds are for “the protection of all persons supplying labor and material in the prosecution of the work,” the costs of physical labor performed on the job site will be recoverable. The cost of professional services, such as architects, engineers, and estimators, will not be recovered unless these services include on-site supervision or other on-site duties.14 Similarly, the cost of office personnel, standing alone and without on-site responsibilities, is not recoverable on the bond. However, in practice, all such home office expenses are figured into the contractor’s bid. Any on-site contractor seeking the balance of its contract will also be able to recover these off site costs.

Material

The cost of most materials will be recoverable. The only frequently disputed issue involves the cost of materials or equipment not consumed in the performance of the work, such as tools and equipment. If a set of equipment tires is reasonably expected to be used up or consumed on this particular project, then the bond will cover the cost of those tires.15 If a contractor buys new equipment for a project, but the equipment is expected to have a useful life after completion of the project, the cost of this equipment will not be recoverable.16

Rental Equipment

If the claimant had to rent equipment to perform its work, the cost of those rentals will be covered under the Miller Act and most Little Miller Acts.17

Material Not Actually Used

Common problems include materials delivered to one (bonded) job site but later moved to another job site. If the material supplier reasonably believed that the materials would be used on the bonded job site, their value will be recoverable under the bond.18 A bond claim will not be defeated if the materials are never actually incorporated into the project or if they are moved to another project.19

Delay and Constructive Change Costs

Some federal courts have ruled that the actual costs of delay20 and other constructive changes are recoverable as costs of providing labor and material to the project.21 However, lost profits caused by delay are not out-of -pocket expenditures for “labor and material” and consequently are not recoverable under the Miller Act.22

Interest and Attorney’s Fees

The Miller Act now states that payment bonds shall be security for the “amount unpaid” claimants.23 Earlier versions of the Miller Act stated that the payment bonds were security for “sums justly due” claimants.24 Under this former “sums justly due” language, most federal courts held the surety liable to pay all interest or attorney’s fees that are justly due to the claimant under the contract or under any federal law.25

We do not yet know whether the change in language from “sums justly due” to “amount unpaid” claimants makes a difference in this result. It would seem that the logic discussed below would still apply and that claimants may still be entitled to interest and attorney’s fees. We will need a few court decisions to give us guidance. Even with the change in federal language, many Miller Act Bond forms, State Little Miller Acts and private bond forms, however, still use the “sums justly due” language. This is discussed further in the section on Bond Forms below. Case law interpreting the former language of Miller Act may remain useful for this reason.

Under the “sums justly due” language, a claimant must still have a contract requiring payment of attorney’s fees or interest above the legal rate before the surety is liable for these sums.26 Notice that this language focuses on what is due the claimant, not on who owes the claimant. If the bond principal has signed a contract with the claimant calling for 18% interest and attorney’s fees on default, then these costs are “sums justly due” to the claimant. A second tier claimant, however, may have a contract that includes costs of collection. This second tier claimant would not have any contract claim for costs of collection from the bond principal because the claimant and principal have no contract between them. However, the collection costs would still be sums justly due the claimant from the intermediate contractor and may be recoverable under the bond.27 Similarly, the words “amount unpaid” may lead to the same result. Check our website for newsletters on this subject.

State law usually allows recovery of a legal rate of interest on any contract debt, even if there is no written contract term. The federal court will look to such state law or some other federal law to determine whether interest is a sum justly due the claimant. If the claimant has a contract term calling for interest above the state legal rate, then this higher rate may also be due under the bond.28

The Virginia Little Miller Act does not use the “sums justly due” language, but requires payment bonds “conditioned upon the prompt payment for all such material furnished or labor supplied or performed in the prosecution of the work.”29 The Maryland Little Miller Act similarly requires “security to guarantee payment for labor and materials.”30 This difference in language between the federal Miller Act and the Little Miller Acts means that these state statutes probably do not extend bond coverage to contract claims that are not for labor or materials.

Some state Little Miller Acts still use the “sums justly due” language. The District of Columbia Little Miller Act, for example, follows the language of the former Miller Act.31 It is more likely that state courts would follow federal case law and allow a claim for contractual rates of interest and attorney’s fees if the state law uses this same language.

Even if the state Little Miller Act does not use the “sums justly due” language, the actual bond forms used by the surety might. The surety and bond principal may voluntarily subject themselves to this liability, even though it is not required by statute. This is discussed further in the section on Bond Forms below.

Notice Requirements for Claimants

There are no notice requirements for first tier claimants who deal directly with the contractor providing the bond. As discussed below, the first requirement for first tier subcontractors is to file suit on the bond within one year of last work. This makes sense since the nonpaying contractor knows it has not paid its subcontractors. Persons farther down the chain, however, have very strict notice requirements.32

Time Limits for Notice

A second tier claimant must provide written notice to the prime contractor within 90 days from the date on which the claimant supplied its last labor or material for which the claim is made.33 The notice must state with substantial accuracy the amount claimed, the name of the party to whom the labor or material was furnished or supplied and that the claimant looks to the bond principal for payment.34 The notice should make it clear that a claim is being made on the bond and that the claimant is looking to the bond principal for payment. This notice allows the prime contractor to protect itself by withholding money from its non-paying sub.35

The federal Fourth Circuit Court of Appeals, which includes Virginia and Maryland, has decided that the bond principal must receive the notice with the 90 days.36 All claimants should make sure to leave enough time for actual receipt of the notice within the 90-day deadline.

Notice that the time limits runs from the date of last labor or for which the claim is made.”37 This means that paid or C.O.D. deliveries will not extend the time for notice of bond claim.38 The claimant is not “making a claim” for paid deliveries and the notice must be sent within 90 days of the last delivery “for which the claim is made.” The language of Miller Act and the Little Miller Acts in Virginia, Maryland, Pennsylvania and the District of Columbia are the same in this regard, so each of these state courts would probably come to the same result.

As we will discuss below, the time limit for filing suit does not use this “for which the claim is made” language, so paid or unpaid deliveries can extend the time for filing suit to enforce bond rights.

Completion of Project and Claimant’s Last Work

How do claimants know when their work on a project has been completed? Does trivial work, warranty work, or repair work extend the deadline for filing suit on the bond?

The answers to these questions are extremely fact-sensitive. That means the answer depends on the particular facts in each case. Courts will look to the nature of the work performed in light of the overall project.39 Factors courts will consider include the value of the materials supplied, the original contract specifications, the unexpected nature of the work, and the importance of the materials to the operation of the system in which they are used.40 Different courts sometimes seem to give inconsistent results although we can see a few consistent themes.

It does seem that long periods of time without supplying labor or material can be a problem. If a contractor has pulled its crew off the job, has requisitioned full payment and been paid, then supplying a small amount of work months later may not extend the time to make a bond claim. The less time that a contractor has been off the job and the more substantial the labor or material supplied, the more likely that a court will find that the time was extended.

It also makes a difference whether the owner or general contractor required or demanded the additional work. 41 It is difficult to demand additional work because the contract is not yet complete and then later argue that contract was complete earlier. Responding to demands from an owner or general contractor helps a court determine that the claimant was “acting in good faith.”

Some courts are concerned with the difference between “warranty” and “repair” work. Many contracts have warranty periods of a year or more. If a project really was one hundred per cent complete at one time and the contractor declared they were complete by requesting full payment, “warranty” work months later may not extend the time.

The federal courts seem fairly set that repair work will not extend the time to provide notice or to file suit. The bigger question is to determine whether the work was repair or pursuant to completing the original contract.42 The “test to be applied is whether the work was performed and the material supplied as a ’part of the original contract’ or for the ’purpose of correcting defects’, or making repairs following inspection of the project.”43

The Virginia Supreme Court has held that so long as “a claimant does work in good faith, at the request of the owner and for the purpose of fully completing his contract according to its terms, the period required for giving the notice under the provisions of the bond runs from the time of the completion of such additional work.”44

The Maryland Cases dealing with this issue reject the idea that they must follow precedent based on the Federal Miller Act. The date from which the 90 day provision is to run is the date the last work necessary to complete the contract was performed or the date the last of the materials necessary to complete the contracts were furnished.45 The Maryland Courts have also stated that they will follow the rule they use for determining the deadline to file a mechanic’s lien, which is generally better for claimants than the federal bond cases.46

A claimant’s recovery can often depend on whether it is a state, federal or private project.

Form of Notice

The bond claim notice need not follow any special form so long as it states with substantial accuracy the amount claimed, the name of the party to whom the labor and material were furnished and that the claimant looks to the bond principal for payment. A letter including these items is usually sufficient, clearly stating that a claim is made on the bond. An example is provided at Appendix 28. It is safer, however, for claimants to include invoices or other details of the transaction. This will also help document the claim, makes it easier for the prime contractor or surety to investigate the claim, and make the prime contractor more likely to withhold money from the non-paying subcontractor.

Under the former Miller Act, 40 U.S.C. §270(b)(a) the bond claim notice had to be sent by registered mail. Now, as revised, the Miller Act allows written notice by any means that provides written, third-party verification of delivery.47 This would include commercial couriers or delivery services such as Federal Express. Even before these revisions, some courts held that actual notice is sufficient. In other words, if the prime contractor has received copies of invoices or a letter by hand delivery or regular mail, this may be sufficient notice under the bond.48

Written notice is still necessary. Oral notice is never enough unless the bond principal has acknowledged the claim in writing.49 However, there is no reason for a potential claimant to take a chance on notice. Written notice should always be sent multiple times, in multiple methods and to multiple addresses, including to the owner, general contractor and surety company. If a claimant finds that it has failed to give proper notice within the time limit, the claimant should investigate whether the prime contractor received actual written notice within the time limit by some informal method.

Recipients of Notice

While the claimant must give notice to the prime contractor, additional notices should be given to other interested parties. Notice should be sent by certified mail to the bonding company and perhaps to the owner of the project. This will help insure that the prime contractor does receive actual notice in case there was a problem with the first mailing. This also helps the claimant obtain payment as a practical matter. If the bonding company and the owner of the project are aware of a problem, they may put pressure on the prime contractor to resolve the problem and they may withhold payment from the prime contractor. Claimants must weigh the benefits of this extra insurance against the potential political problems of involving the owner.

Enforcement of Bond Claims

Bond claims are enforced by filing suit against the surety in the proper court. Federal Miller Act suits must be brought in the U.S. District Court for the District where the project is located.50

Time Limits for Enforcement

A claimant is not permitted to enforce its bond rights by filing suit until 90 days after the last supply of labor or materials for which a claim is made.51 This is a “nuisance” provision to prevent unnecessary litigation. A claimant must wait these 90 days in order to give the bond principal and surety a chance to make sure proper claimants are paid.

The same “for which a claim is made” language is used here. Therefore, paid or C.O.D. deliveries will not prevent a claimant from filing suit, just as paid or C.O.D. deliveries will not extend the time for notice of bond claim.52 The claimant is not “making a claim” for paid deliveries. The language of Miller Act and the Little Miller Acts in Virginia, Maryland, Pennsylvania and the District of Columbia are the same in this regard, so each of these state courts would probably come to the same result.

All bond claimants must enforce their claims within one year after the last of the labor was performed or material was supplied by the person bringing the action.53 This is the “statute of limitations” for the claim. If a claimant waits more than one year, the claim is lost.54

As discussed above, it is important to notice the difference in the “trigger” date for the 90-day notice requirement and stay period on the one hand and the “trigger” date for the one year “statute of limitations” for filing suit on the other hand. A sub-subcontractor claimant must give notice of its bond claim to the bond principal within 90 days after the last supply of labor or materials for which a claim is made. No claimant is permitted to file suit until 90 days after the last supply of labor or materials for which a claim is made.55 However, the deadline for filing suit is one year after the last of the labor was performed or material was supplied by the person. Therefore, paid or C.O.D. deliveries will not extend the time for notice of bond claim or prevent a claimant from filing suit, but paid or C.O.D. deliveries will extend the time for filing suit on the bond. The language of Miller Act and the Little Miller Acts in Virginia, Maryland, Pennsylvania and the District of Columbia are the same in this regard, so each of these state courts would probably come to the same result.

Each federal prime contract is a separate project for the purposes of this time limit. Separate federal contracts may cover a single building or group of buildings. More than one contract may go to a single general contractor. Each contract, however, will have its own payment bond. If a claimant is supplying labor or materials for more than one prime contract, then that claimant must keep track of the last labor or material supplied for each contract. The time limits for notice and for filing suit will be from the last labor or material supplied for each prime contract or project.

Parties and Claims in Enforcement Suit

The claimant must sue the surety within the time limit to preserve bond rights. The claimant may also name additional defendants and bring other claims in the same suit.56

The claimant will usually have a contract for the supply of labor or materials. The claimant can name its “contract debtor” as a party to the lawsuit and seek to enforce contract rights.57 The contract debtor, the person with whom the claimant contracted, may or may not be the same person as the bond principal. A second tier subcontractor, for example, did not contract with the prime contractor/bond principal. This second tier subcontractor has rights against the bond and contract rights against the first tier subcontractor with whom he entered the contract.

In addition to the surety, the bond principal signs the bond and also has obligations under the bond if all proper claimants are not paid. This bond is another type of contract signed for the benefit of the claimant. A bond claimant can sue both the surety and the bond principal on this (bond) contract.

This means that a first tier claimant can sue: (1) the surety on the bond, (2) the prime contractor on the bond and (3) the prime contractor as the contract debtor. The prime contractor’s obligations to this first tier sub under the contract will vary from its obligations under the bond. It can be a tremendous advantage to the claimant to sue under both sets of obligations.

A second tier claimant can sue: (1) the surety on the bond, (2) the prime contractor on the bond and (3) the first tier subcontractor with whom it had a contract (contract debtor). Thus, the second tier claimant also has an additional defendant, hopefully with deep pockets, from whom he may be able to collect.

A claimant does not have to enforce all of these rights but has the option to pick and chose which to enforce. This can be important for political reasons in that it allows the claimant to avoid suing a longstanding customer. This is also important in the case of bankruptcy. If the contract debtor has filed for bankruptcy, the “automatic stay” prevents anyone from filing suit against this debtor. A claimant can elect, however, to refrain from suing the bankrupt debtor and go against the other candidates.

Arbitration Clauses

Many construction contracts have arbitration clauses. All courts seem to agree that arbitration clauses between contractors are enforceable even if the plaintiff sues to enforce his bond rights. Arbitration clauses will still affect the timing of bond suits, the order in which they proceed and the parties to the suit. On these issues, even different federal courts have come to different results. A bond claimant’s biggest practical concern will be to avoid multiple suits and delays by making sure the surety is included and bound by any proceeding.

A public bond claim must be enforced in accordance with the public statute requiring the bond. All public bonding statutes include strict rules about the court location for the suit. These rules must be carefully followed to preserve rights.58 As a practical matter, this usually means all claimants will need to file a lawsuit to enforce bond rights within one year of last work. This lawsuit should normally include the contract debtor/bond principal. Both parties can waive an arbitration clause if the contract debtor/bond principal decides not to enforce the arbitration clause.59 This leaves the parties with a single lawsuit, frequently the best result for everyone.

An arbitration clause will be enforceable between the parties to the contract containing the clause.60 If a claimant sues a contract debtor, that contract debtor will be able to get the action stayed or dismissed and force the claimant to seek arbitration instead. Can the claimant force the surety to arbitrate also? Can the claimant continue to sue the surety on the bond while arbitrating with the contract debtor? Courts differ in their answers. In the dance that follows, the claimant should focus on keeping the two cases together and avoiding two trials.

Most bond forms refer to the contract and incorporate the contract by reference. Some courts have held that this incorporates the entire contract, including the arbitration clause, and the surety is bound to arbitrate. Courts have allowed a surety to compel arbitration, even thought the surety was not a signatory of the subcontract with an arbitration clause.61 A claimant that decides to arbitrate should also seek arbitration against the bonding company. Arbitrators will sometimes rule that the surety can be forced to arbitrate. The surety will then be bound by the results of the arbitration, and the claimant may avoid two trials.

If the surety successfully gets out of the arbitration proceeding, at least the surety will not be able to later argue that it had no notice of the arbitration and no opportunity to present evidence. If the surety is not bound to arbitrate, then it would seem that the claimant would not be bound either. The claimant should be able to dismiss or stay the arbitration with the contract debtor/bond principal and proceed directly against only the surety in court.62 This would again avoid multiple suits. Remember that the claimant will probably have to file a lawsuit against the surety anyway to preserve bond rights.63

If the claimant does arbitrate against the contract debtor only, there is a risk that the claimant will have to try the same case twice. If the contract debtor is solvent and the claimant can enforce an arbitration award against the contract debtor, it will never be necessary to go against the surety. However, if the contract debtor is insolvent the claimant now has an uncollectible arbitration award.

Some courts will hold that this arbitration award is conclusive against the surety, especially if the surety had notice of the arbitration.64 Most courts will hold that the surety has “personal defenses,” such as lack of notice under the bond or that the claim is not covered under the bond. This will avoid the need to relitigate the factual issues concerning the debt, but a separate proceeding on these personal defenses will still be necessary. In some situations, the surety will be allowed to relitigate the underlying debt to the claimant and this is the situation the claimant wants most to avoid.

Waiver of Payment Bond Rights

Waivers of bond rights can appear in a contract for labor and material or they can be in a progress payment waiver form, just like waivers of mechanic’s lien rights. Waiver forms vary greatly in their wording and effect. Contractors must learn to recognize and revise what they are signing, as is discussed in detail above in the chapter on Contracts & Preserving Rights, section on Contract Administration, Waiver Forms.

There will be times that you have the opportunity to use your own waiver form. You want to be able to safely do that. The form at Appendix 11 protects the interest of the owner or general contractor without eliminating legitimate security rights for unpaid labor or materials.

All types of waivers must be “clearly and unambiguously expressed.” This rule is meant to protect legal rights. Persons should not be able to accidentally waive legal rights. This general rule on waivers also applies to waiver of bond rights. If there is doubt as to whether a waiver was given, then the claimant will likely retain bond rights. In addition to this general rule, the U.S. Congress and some state legislatures have created further protections for payment bond rights.

A potential federal Miller Act or Virginia Little Miller Act claimant cannot waive its payment bond rights prior to supplying labor or materials.65 For a waiver to be valid, the waiver must be in writing and signed by the person whose right is waived.66 Courts strictly construe the waiver requirements in favor of those providing labor and materials.67

In addition, the Maryland Code prohibits any waiver of bond rights that is contained in an executory construction contract. Any waiver of bond rights must be in a separate document, or it is void as a matter of public policy.68 This means that contractors could possibly waive bond rights in Maryland before supplying labor or material, but this waiver cannot be in the contract to supply labor or material. It must be in a separate document. This policy applies to public and private bonds for construction projects located in Maryland. Pennsylvania and the District of Columbia have no protection against waivers in contracts.

The bottom line is that bond waivers in a contract are unenforceable on any federal project, and public contract in Virginia, or in any public or private contract in Maryland. A progress payment waiver after labor and material are supplied, however, can eliminate bond rights even if the claimant has not been paid. Accordingly, all contractors and suppliers should still be careful to review contracts and eliminate lien or band waivers to be safe. Contractors should also make all progress payment bond waivers conditional, as discussed in the Contracts & Preserving Rights chapter.

Getting Copies of Bonds

The payment bond security rights available is important information to collect on a construction project. How do you find out whether a project is bonded? How do you get a copy of the bond?

There is no question it is best to get copies of bonds early. Subcontractors and suppliers want to know what security rights they have before agreeing to supply labor and materials. If a project is bonded, then the risk factor is lower and they can bid the project far more aggressively. It is also far easier to collect such information while everyone is still friendly. Debtors, general contractors and owners are not as likely to cooperate once labor and materials are already supplied and problems occur. When a customer is more than 60 days past due, they are not likely to return phone calls, much less provide copies of payment bonds. Once there is a problem, claimants will also be very short on time.

On public projects there are legal mechanisms to get copies of bonds, such as the Freedom of Information Act discussed below. After a problem has developed, however, claimants will be so short of time that these legal mechanisms may not help much. If the project is a public construction project and large enough to be covered by a Miller Act, at least a claimant knows that there is supposed to be a bond. The claimant knows that notice to the general contractor within ninety days of last work will preserve bond rights in the short run. The claimant can and should send that notice, whether or not they have a copy of the bond.

On a private project, it is impossible to know whether a project is bonded unless someone gives the claimant a copy of the bond. It is also impossible to know the terms of the bond or where the claimant must send notice. Private bond forms often require notice to the owner, the bonding company and/or the general contractor.

If a claimant failed to get a copy of the bond before supplying labor or material, the best tact is to simply send a notice to every name and address available, making a claim on the bond and requesting a copy. A claimant does not need to know there is a bond to make a claim on the bond. It is impossible to send notice to too many people. The notice will often produce a copy of a bond. Even if it does not, making all players on the project aware of a payment problem will tend to freeze money and help a claimant collect. An example of a bond claim notice is provided at Appendix 28.

It will be necessary to get a copy of the bond, or at least find out the name of the bonding company, in order to file suit on the bond. A claimant normally has a year after last work to file suit, however, so this is less often a time pressure concern. Even without a copy of the bond, it is actually possible to file suit on the bond just against the general contractor. The bond is an “undertaking” or agreement by the bonding company and the general contractor to pay all claimants.

A general contractor will not advertise the fact that the job is bonded and may be very reluctant to provide a copy of the bond. There is normally no rule saying they have to provide copies of bonds and they usually do not want to. This general contractor will be at risk to pay the bond claims, even if that general contractor has paid all of their subcontractors in full. Owners are usually the most motivated to provide copies of bonds. Private owners required the bond to avoid mechanics' liens. A threat of lien will often produce a bond from an owner. Public owners are often required to provide copies of bonds.

The federal Miller Act, as well as the Little Miller Acts in the District of Columbia69, Maryland70, and Pennsylvania71 designate certain government officials who provide certified copies of payment bonds and prime contracts to claimants who submit an affidavit stating that they provided labor or materials to the project and have not been paid. Virginia allows anyone to make a request in accordance with the Virginia Freedom of Information Act72 and the Virginia Little Miller Act.72 and the Virginia Little Miller Act.73 In other words, in Virginia you do not need to be an unpaid claimant to receive such documents.

The Freedom of Information Act74 or FOIA has also improved public access to federal agency records regarding public construction projects. Many states have adopted similar legislation.

The Freedom of Information Act normally just requires a written request for information. The keys are directing the request to the right person and making as specific a request as possible. Requesting “all of the documents regarding the project” will often result in an objection from the government and will always delay production. The government can charge for the cost of reproduction and that is another reason to make requests short and specific. A request for a copy of the Payment bond provided, along with a good description of the project, is normally the best request.

Federal agencies are required in the Federal Register to provide contact and procedural information for making information requests.75 State agencies often also have FOIA officers. Phone calls to the contracting agency will normally determine the name and address of the FOIA officer for that agency. It is often helpful to also send the FOIA request to the contracting officer and a government attorney, if this information is available, since they may be in a better position to respond promptly.

The Freedom of Information Act is an effective method to get bonding and contract information, but normally takes too much time to help after a problem has developed. Potential claimants should consider making FOIA requests early in a project, before a problem develops and perhaps even during the bidding process. The FOIA officer will probably not even inform the contractors involved that a FOIA request was received.

Miller Act Performance Bonds

Any federal government contract requiring a payment bond will also require a performance bond. Payment and performance bonds are required for any contract for the alteration or repair of any public building or public work of the United States that is for an amount greater than $100,000. 76

The performance bond is for the benefit of the government owner, providing security that the project will be completed in a timely and workmanlike manner.77 Usually, the bond company can either take over and complete the project or allow the government to complete it and pay the costs incurred.

Only the government can make a claim under a performance bond for completion of a project. Suppliers of labor and material can seek payment only under the payment bond.78 However, the payment bond and performance bond is sometimes included in one document. It can also be important to read the operative language in a payment or performance bond. It does not matter that a document is entitled “Performance Bond,” if the operative language guarantees payment to all subcontractors supplying labor or material to the project.

Virginia Little Miller Act

The Virginia Little Miller Act is found as a part of the Virginia Procurement Act, Virginia Code Section 2.2-4337 through 4342. This outline will focus on the differences between the Virginia Little Miller Act and the federal Miller Act. The outline on the federal Miller Act above should be consulted for a general discussion of public project bonds. State courts will tend to follow the federal courts in interpreting bond statutes,79 although differences in the wording of the Acts can yield different results and state courts are not bound to follow the federal courts in any event.

The Virginia Procurement Act applies to all procurements by the state, counties, cities, and their agencies such as the Virginia Department of Transportation, state universities, and all county school boards. Virginia requires bid, performance and payment bonds for construction contracts in excess of $100,000.80 Bonds may be required for smaller construction contracts. A contractor may provide a certified check or cash escrow as alternative security instead of a bid, performance, or payment bond and, with permission, may substitute a personal bond, property bond or letter of credit.81

The government can generally bring an action against the surety on a performance bond “within one year after (i) completion of the contract, including the expiration of all warranties and guarantees, or (ii) discovery of the defect or breach of warranty…”82 This “discovery” provision can leave sureties and bond principals open to claims for an indefinitely long period of time. For example, the Virginia Department of Transportation can bring an action within five years of completion of the work on their projects.

Virginia Payment Bonds

Possible Bond Claimants

The Virginia Little Miller Act payment bond shall be “for the protection of claimants who have and fulfill contracts…to the prime contractor…or to any subcontractor…” It seems, therefore, that protection extends to the second tier.83 No Virginia Court has decided that a “mere materialman” is not a subcontractor. Second tier materialmen should consider making a claim on a payment bond on Virginia projects. State courts may follow federal case law on this issue, however, since State Little Miller Acts are patterned after the federal Miller Act.

Subcontractor Bonds

Any prime contractor may require payment bonds from their subcontractors.84 These subcontractor bonds are not required by statute, so the coverage required by the bond is not dictated by law. The rights described in the bond form control, as the contract made by the surety and the bond principal.85 The bond form may allow claims by anyone supplying labor or materials to the project. See the section on Bond Forms below.

Can lower tier claimants make a claim against any subcontractor bond and the general contractor’s bond? The Virginia statute seems to provide that a general contractor’s bond is immune from lower tiered claimants if a subcontractor bond is provided. General contractors should be careful that this immunity is repeated in the general contract bond form. Otherwise, the general contractor may still be subject to suit from lower tiered claimants.86 What if a subcontractor bond is required, but the sub bond has a 90-day notice requirement instead of the 180 days required in the Virginia Act? Is the general contractor still protected from claims by a sub-subcontractor making claim after 100 days? These are common problems found when using the bond forms discussed below.

Notice Requirements for Claimants

Anyone dealing directly with the bond principal is not required to give notice of their bond claim until the suit to enforce.87 The bond principal would be the prime contractor on most jobs but may also include subcontractors providing their own payment bonds.

Anyone who did not deal directly with the bond principal must give written notice of their claim to the bond principal.88 Notice must be given within 180 days after “the claimant performed the last of the labor or furnished the last of the materials for which he claims payment.”89 A claim for sums withheld as retainage is not subject to any time limit for notice.89 A claim for sums withheld as retainage is not subject to any time limit for notice.90 These time limits are much more generous to claimants than the federal Miller Act or the Little Miller Acts enacted in any state near Virginia.

These provisions can leave a general contractor vulnerable to claimants with whom it did not contract for an extended period of time. The general contractor may not even know that the claimant was supplying labor or material to the project. As a result, general contractors must take great care before releasing progress payments or retention. See the section on Pitfalls for General Contractors below. General contractors should also seriously consider requiring subcontractor payment bonds.91

Enforcement of Bond Claims

Any action on a payment bond must be brought within one year after the last day the claimant supplied labor or materials.92 The action must be brought in the Circuit Court for the county where the project is located.93

Maryland Little Miller Act

Maryland’s Little Miller Act is located in Maryland State Finance and Procurement Code Sections 17-101 through 17-110. This outline will focus on the differences between the Maryland Little Miller Act and the federal Miller Act. The outline on the federal Miller Act above should be consulted for a general discussion of public project bonds. Maryland courts will tend to follow the federal courts in interpreting bond statutes.94 However, differences in the wording of the two acts may yield different results and state courts are not bound to follow the federal courts in any event.95

Note that the Maryland Code prohibits any waiver of bond rights that is contained in an executory construction contract. Any waiver of bond rights must be in a separate document, or it is void as a matter of public policy.96 This policy applies to public and private bonds for construction projects located in Maryland.

The Maryland Little Miller Act applies to construction contracts by the state, counties, municipal corporations, other political subdivisions, public instrumentalities, and government units authorized to award a contract.97 Performance and payment bonds are required for construction contracts in excess of $50,000.98 Bonds may be required for construction contracts between $25,000 and $50,000.99 Apparently, a bond is never required for contracts below $25,000. A bid bond is required on any contract over $50,000.100

Maryland Payment Bonds

Any person who has supplied labor or materials on a public construction contract, but has not been paid, can obtain a certified copy of the required payment bond by submitting an affidavit to the State Comptroller or the officer in charge of keeping the bond.101 This required production of the bond is an aid to claimants, who otherwise might be unable to obtain a copy of the bond. However, it apparently does not help claimants until they have a payment problem.

The prime contractor on the construction contract can provide security in the form of a bond, cash, or other security acceptable to the public body awarding the contract.102 This could be a problem if a public body makes the mistake of accepting inadequate security. Subcontractors and suppliers may wish to determine exactly what form of security has been provided before providing labor or materials to a project.

Possible Bond Claimants

The Maryland Little Miller Act explicitly extends to claimants one tier lower than the federal or Virginia Acts. Maryland State Finance and Procurement Code Section 17-108 allows suit on the bond by any claimant with a direct contractual relationship with a subcontractor or sub-subcontractor of the prime contractor.103

Maryland follows federal law in holding that a “mere materialman” is not a subcontractor.104

Notice Requirements for Claimants

Claimants with a direct contract with the prime contractor are not required to provide notice of their bond claim until filing suit. All other claimants must provide written notice “within 90 days after the labor or materials for which the claim is made were last supplied.”105 The notice must be sent certified mail to the prime contractor’s residence or office, and must state with substantial accuracy both the amount claimed, the person to whom the labor or material was supplied106 and that the claimant looks to the bond principal for payment.106 and that the claimant looks to the bond principal for payment.107

Enforcement of Bond Claims

A claimant can file suit on the payment bond up until one year after the public body finally accepts the work performed under the contract.108 This can greatly extend the time for filing suit beyond the time permitted under the federal or Virginia acts. Claimants dealing directly with the prime contractor, and therefore not required to give notice, may be inactive on their rights and still have bond rights years after they supplied a project depending on when the work is finally accepted.

A claimant is still not permitted to file suit on the bond until 90 days after the last supply of labor and materials for which the claim is made.109 Suit must be brought in the Circuit Court where the prime contract was executed and performed or where the prime contractor has its principal place of business.110

No Waiver in Subcontract

The Maryland Code does not allow bond claim waiver in construction subcontracts.Some general contractors use contract forms stating that subcontractors “hereby waive all rights to a bond claim.”Such a provision in a subcontract waiving mechanic’s lien or payment bond rights is “void as against public policy” in Maryland.111 It is still possible to waive mechanic’s lien or bond rights in a document separate from the construction subcontract.

A “pay when paid” clause will not defeat bond rights.112A subcontractor may (and is probably still required to) enforce bond rights within the time deadline, even though the subcontract states that payment is not due until the owner has paid the general contractor.

Pennsylvania Little Miller Act

The Pennsylvania Little Miller Act is found in the Public Works Contractor’s Bond Law of 1967, Title 8 P.S. § 191, et seq. Award and Execution of Public Contracts, Title 73 P.S. § 1621, et seq. provides for additional requirements in relation to the bond law.113 This outline will focus on the differences between the Pennsylvania Little Miller Act and the federal Miller Act. The outline on the federal Miller Act above should be consulted for a general discussion of public project bonds. State courts will tend to follow the federal courts in interpreting bond statutes,114 although differences in the wording of the Acts can yield different results and state courts are not bound to follow the federal courts in any event.

The Pennsylvania Public Works Contractor’s Bond Law applies to all public contracts for the Commonwealth of Pennsylvania, any local authorities, or any state aided institution.115 Pennsylvania requires a performance and payment bond for public contracts in excess of $5,000.116 Contractors may provide any financial security that is acceptable to and approved by the contracting body, including irrevocable letters of credit and restrictive or escrow accounts from a federal or Commonwealth of Pennsylvania lending institution.117

Pennsylvania Payment Bonds

Possible Bond Claimants

The Pennsylvania Public Works Contractor’s Bond Law requires both payment and performance bonds. The payment bond is “for the protection of claimants supplying labor or materials to the prime contractor…or any of his subcontractors…”118 Payment bond protection, therefore, extends only to second tier suppliers of labor and materials to the general contractor or subcontractor.119 Pennsylvania courts have also decided that a “mere materialman” is not a subcontractor, and therefore a supplier to a supplier has no bond rights.120 Accordingly, Pennsylvania state courts follow federal case law on this issue, since the state Little Miller Act is patterned after the federal Miller Act.121

Notice Requirements for Claimants

Anyone dealing directly with the bond principal is not required to give notice of their bond claim until the suit to enforce.122 The bond principal would be the prime contractor on most jobs but may also include subcontractors providing their own payment bonds.

Anyone who did not deal directly with the bond principal must also give written notice of their claim to the bond principal.123 Notice must be given within 90 days after “the claimant performed the last of the labor or furnished the last of the materials for which he claims payment.”124 The notice must state with substantial accuracy the amount claimed, the name of the person for whom the work was performed and that the claimant looks to the bond principal for payment.125 Courts have ruled that a notice that failed to state any amount due is completely defective.126

The notice must be served by registered or certified mail to the bond principal at any regular place of business. If the notice is actually received, however, the absence of service by registered mail is not of legal significance.127

Enforcement of Bond Claims

Any action on a Public Works Contractor’s Bond must be brought within one year after the last day the claimant supplied labor or materials.128 Subsequent repairs performed by a subcontractor do not extend this one-year period.129 Furthermore, a suit against a payment bond cannot be filed until the end of a 90-day waiting period after the last day the claimant supplied labor or materials.130 The suit must be filed in the county where the project is located.130 The suit must be filed in the county where the project is located.131 Any person who has supplied labor or materials on a public contract, but has not been paid, can obtain a certified copy of the required payment bond by submitting an affidavit.132

Possible Bond Claims—Compensable Costs

Payment bonds cover the payment of “all material furnished or labor supplied or performed in the prosecution of the work.”133 Labor or materials includes public utility services and reasonable rentals of equipment. However, the rental is limited to equipment that is actually used at the site.

Finance charges above the legal rate and attorney’s fees also do not constitute labor and materials and are not recoverable under a Pennsylvania Public Works Bond, unless expressly included in the bonding agreement.134 In addition, a claim for lost profits135 and damages for delay are not recoverable against a bond.134 In addition, a claim for lost profits135 and damages for delay are not recoverable against a bond.136 Attorney’s fees and interest above the legal rate are not recoverable from the surety under Pennsylvania law.137 However, interest at the legal rate is recoverable.137 However, interest at the legal rate is recoverable.138

Defense of Payment Under Pennsylvania Little Miller Act

Under the Federal Miller Act and the various state Little Miller Acts discussed previously, there is no “defense of payment” available to the bond principal or the surety. In other words, if a general contractor pays its subcontractor in full on a project, but that subcontractor fails to pay its supplier or sub-subcontractor, the unpaid claimant still has recourse against the general contractor and the surety on the payment bond. It does not matter that the general contractor has already paid its subcontractor. The unpaid supplier or sub-subcontractor can force the general contractor to pay again.

This is no longer the situation, however, and there is now a defense of payment on a Little Miller Act bond in Pennsylvania. A Pennsylvania court, interpreting a change in Pennsylvania’s Prompt Payment Act,139 recently held that once a general contractor has made payment to a subcontractor, future claims for payment against the general contractor or the general contractor’s surety are barred.140

District of Columbia Little Miller Act

The District of Columbia Little Miller Act is almost identical to the former federal Miller Act.141 The outline on the federal Miller Act above should be consulted for a discussion of public project bond requirements in the District. Although District of Columbia Courts are not technically bound to follow the federal courts in interpreting bond statutes, they can be expected to.

Under the District of Columbia Act, the Mayor’s office makes all decisions concerning bonds.142 The Mayor’s office may require bonds for contracts less than $25,000 and “may waive the requirements for performance and payment bonds in such cases as he shall determine.”143

Any person who has supplied labor or materials on a public contract, but has not been paid, can obtain a certified copy of the required payment bond by submitting an affidavit to the Mayor.144

Suits to enforce bond rights may be brought in the District of Columbia Superior Court within one year after the last supply of labor or materials.145 Suits also may be brought in federal court if diversity or other grounds for federal jurisdiction exist.146

Pitfalls for Subcontractors and Suppliers on Public Projects

Payment bonds are generally better security for subcontractors and suppliers than mechanic’s lien rights. Bond rights are usually less expensive to enforce. There is no “defense of payment” under a payment bond. Even if a general contractor has paid all of its subcontractors in full, an unpaid sub-sub or supplier with protection under the bond can still force the general contractor to pay again. This puts the burden on the general contractor to make sure that all subcontractors forward payment to their creditors. For this reason, general contractors on public projects often require subcontractors to provide their own payment bonds.147

However, there are dangers for subcontractors and suppliers on public projects. Subcontractors must remember that they have no mechanic’s lien rights on public projects, even if their payment bond rights fail.

In an initial credit evaluation for each project, subs and suppliers should review the payment bond requirements of the particular municipality involved. Requirements vary slightly on federal projects and in each state. Local municipalities may have additional requirements. It is very dangerous for a subcontractor or supplier to assume that a new project will have the same requirements as the last. The safest course is to obtain a copy of the bond during an initial credit evaluation and before bidding on the project. The legal requirements for the particular government entity involved should also be reviewed. These legal requirements are reviewed in earlier sections of this book. The following are general considerations for contractors on all government projects.

No Bond Required

Bonds are not required on every public project. Accordingly, contractors should make a practice of obtaining a copy of the bond on the project in their initial credit evaluation of the project and customer. On federal projects, for example, bonds or alternative security are required only for construction contracts exceeding $25,000. In Virginia, the minimum contract is $100,000 for payment bond requirements. It is also possible for a contracting officer to waive the requirement of a bond on any particular project.

Payment bonds are usually required for construction projects, but less often required for other types of public procurement. Some contractors supply labor or materials that could be part of a “construction contract” or could be part of other types of procurement, such as cleaning services, HVAC equipment, etc.

Multiple general contracts can eliminate the payment bond requirement on larger projects. The government may elect to act as its own general contractor or may hire a construction manager. The trade contractor, who would usually be a subcontractor, now has a contract directly with the government. Any of these contracts that do not meet the minimum dollar amount will have no payment bond requirement. Government agencies may employ this approach to lower costs to the government, sometimes purposefully relieving contractors of payment bond premiums to reduce the bids received from contractors. This may, however, leave subcontractors and suppliers unprotected.

The Government Contracting Officer may require payment bonds for contracts even if not required by law. Claimants should always check the bonding requirements with the owner or contracting officer, especially once payment problems exist. A payment bond may exist on unexpected projects.

Insolvent Surety or Inadequate Security

The existence of a bond does not assure payment to a subcontractor or supplier. The surety may be insolvent and no better able to make payment than the bond principal. Even corporate sureties can fail because of bad business practices, a bad loss history, or inadequate capitalization.

It is very important to remember that a claimant has no recourse if the contract debtor and the surety both fail. It will still be impossible to file a mechanic’s lien on government property. The government has no liability for allowing an insolvent surety to provide the bond or for neglecting to require bonds at all.148

Unfortunately, there are also shady bonding companies who inflate or falsify financial statements in order to meet government qualifications. They will often issue bonds to shady contractors who are unable to obtain other sureties. Large premiums can be charged to provide bonds to risky contractors. Such bonding companies can disappear, however, when large claims appear.

Some government contracting officers are also permitted to approve private sureties. Wealthy individuals are sometimes in the business of providing private surety bonds. Some individuals will also inflate or falsify financial statements in order to qualify.

Insolvent private sureties have been a problem even on federal projects. In one local case, private sureties showed vast real estate holdings on financial statements and were approved by the federal government. After multiple projects failed, many subcontractors and suppliers filed claims against these private sureties. The real estate on the financial statements turned out to be parkland. Subcontractors and suppliers ended up with judgments against an insolvent general contractor and an insolvent surety.149

For corporate sureties, subcontractors and suppliers have ready access to financial rating information such as:

Moody’s www.moodys.com 212-553-0377

Standard & Poor’s www.ratings.com 212/438-2400

Best’s www.ambest.com 908-439-2200 (charges a fee)

U.S. Government approved sureties www.fms.treas.gov/c570

Surety Association of America www.surety.org

A general contractor may not be willing to supply the financial statements of these sureties. In marginal cases, however, a subcontractor may wish to make this a contract condition.

Pitfalls for General Contractors on Public Projects

There is no “defense of payment” on a public payment bond. In other words, the general contractor can be required to pay twice for labor or materials supplied if the general contractor pays all of its subcontractors in full, but some of those subcontractors do not pay their bills. The burden is on the general contractor to make sure that all lower tier claimants are paid.150

The most common protection is to require each subcontractor to produce releases from all of their sub-subcontractors and suppliers. Such releases can be required for all progress payments or just for the final payment. However, it is often difficult for a general contractor to know whether it has received releases from all sub-subcontractors and suppliers. It is a good idea to require each subcontractor to provide a list of all sub-subcontractors and suppliers before the project begins. Subcontractors should also be required to update this list if any new sub-subcontractors are used later in the project. Subcontracts should prohibit the use of unauthorized sub-subcontractors.

General contractor superintendents and project managers must also keep a watchful eye for unauthorized sub-subcontractors and suppliers. Trucks appearing on the site and material shipments should be checked against the list of approved sub-subcontractors and suppliers. These are potential claimants on the payment bond. The office staff will not know to require releases from these unauthorized suppliers unless informed by the field personnel.

General contractors can obtain their greatest protection by requiring all subcontractors to provide subcontractor payment bonds. This will protect the general contractor from all downstream claimants. The subcontractor bond will pay any claims as long as the general contractor makes payments to all of its subcontractors. The subcontractor will, of course, have to pay bond premiums. This will add to the cost of the contract for the subcontractor and will result in higher bids to the general contractor. This is one disadvantage. See also, the above sections on the Virginia Little Miller Act, Subcontractor Bonds and the section below on Bond Forms.

There are also many subcontractors who cannot qualify for a surety bond even though they are honest, do good work, and are capable of completing the project. The subcontractor may have insufficient net worth or may have been in business for a short time. Accordingly, the general contractor may increase its subcontract costs and cut itself off from many good subcontractors by requiring the subcontractor to provide a bond.

Some government agencies require subcontractor bonds in addition to a general contractor bond. The general contractor must consider the increased subcontract costs when bidding such a project. Many general contractors believe that the government should allow them to decide whether to take this risk. The general contractor’s bond will still cover the claims of most lower tier contractors even if no subcontractor bonds are required. A subcontractor bond requirement will only increase the cost of the project to taxpayers. The general contractor is in the best position to assess the credit worthiness of its subcontractors. Larger subcontractors will have less competition from smaller companies if subcontractor bonds are required.

Bond principals should also make sure that they are not taking on unnecessary liability because of the bond form used. Bond claimants have two places they can look to determine whether they have payment bond rights: the bond statute and the bond forms actually used. The bond statute provides minimum requirements. The government must require, and the general contractor must provide, a bond that complies with the bond statute. However, a bond can provide claimants greater protection than these minimum requirements. This can be a source of unnecessary and unintended liability on the part of bond principals.151

PRIVATE PAYMENT BONDS

Private owners may require bid, performance or payment bonds on any project. Such owners often require bonds for the same protective reasons behind public bonding statutes. Bid bonds will ensure that only serious bidders participate in the bidding process and protect owners from the costs associated with bidders who cannot enter a contract in accordance with their bid. Performance bonds will ensure that the project is completed in a timely and workmanlike manner. Private owners, who do not have the public property shield from mechanics’ liens, desire payment bonds for protection from mechanics’ liens.

Some of these concerns are shared by all owners, public and private. Public and private owners, however, do not have all the same objectives in a construction project. Private owners are more concerned with economics and less with public policy. It is a mistake, therefore, for private owners to blindly adopt the bonding policies and bond forms of public entities.

There are no legal requirements as to the bond terms used in a private project. Private owners and general contractors are free to negotiate whatever bond terms will provide sufficient protection to the owner and which the contractor is willing to purchase. Contractors do not want to have unnecessary liabilities and should take the opportunity to negotiate a bond form with fewer risks than the required public bond forms. Owners do not want to pay for protection they do not need as a private owner. Owners and contractors should take care to use a bond form containing terms tailored to their private project.152

If a bond form happens to use language derived from a public bonding statute, the courts can look to public bond case law for interpretation of the words used in the bond. Since there are no statutes controlling, however, private bonds are considered contracts to be interpreted by the courts like any other contract.

Subcontractors and suppliers should not make any assumptions when dealing with private projects. First, they should always determine whether a project is bonded. This is sometimes the most expensive question never asked. Many claims that would be covered by a payment bond remain uncollected because the claimant did not know that the bond existed. Owners and general contractors are not required to advertise the fact that the project is bonded. This is a matter that is privately negotiated between the parties for the protection of the owner. The general contractor may not want potential claimants to know there is a payment bond since bond claims increase their exposure. Subcontractors should contact the owner or architect when payment problems occur and make it clear that a mechanic’s lien will be filed unless the job is bonded and a copy of the bond is provided.

Once subcontractors determine that a job is bonded, they cannot make any assumptions about the terms of the bond. Private bonds are freely negotiated and can contain extra “hurdles” for a claimant. Notice may be required within 60 days of last work instead of 90 days. Notice may have to go to the general contractor and the bonding company. Potential claimants must obtain an actual copy of the bond and read it or send it to counsel for review in order to determine the most effective procedure to preserve rights.

BOND FORMS

Nobody pays enough attention to the bond forms used on a bonded project. Failure to review the actual bond forms for a project can result in: government entities inadvertently exposing general contractors to more risk than is required by the bonding statute; private owners exposing general contractors to risks that do not aid the owner in any way; general contractors exposing themselves to liabilities they could have avoided; and, subcontractors and suppliers failing to preserve rights they may not know they even have.

The American Institute of Architects, the Associated General Contractors and other groups have developed bond forms for use nationwide. Bonding companies, and therefore contractors, tend to use the same bond forms whether the project is public or private, federal or state, Virginia or Maryland. This is administratively easier but leaves contractors and bonding companies with greater exposure than necessary.

Fullerton & Knowles has developed bond forms for owners, general contractors and sureties. These custom forms meet all public contract requirements and provide protection to subcontractors, without creating unnecessary liability to general contractors and sureties.

Bond Forms on Public Projects

The various Miller Acts describe a minimum amount of protection required. The courts have held, however, that there is no reason a contractor or bonding company cannot provide greater protection than required by the statutes.153 The Miller Acts vary from state to state. If a uniform form is used in all jurisdictions, then the form will be below the minimum in some cases and above the minimum in others. Most public entities have a required bond form.

If the form is below the minimum, a court will say that the bonding company is still bound to give the minimum protection.154 If a form is above the minimum, however, the court will say that the bonding company has simply volunteered to provide greater protection than was required by the Miller Act.155 There is uncertainty and some inconsistency in the courts concerning when the statute can be read to supplement bond forms and when a surety has waived allowed statutory protection.

An example of the problem arises out of a 1971 Virginia Supreme Court case that held that if a general contractor wants the protection provided in the Virginia Little Miller Act, then that general contractor must make sure the protective provisions are included in the bond form.156 The Virginia Little Miller Act allows a general contractor to require a payment bond from its subcontractors. At the time the case was decided (under a prior statute), if a subcontractor’s bond was required, then the lower tier suppliers had to sue on that bond and were prohibited from suing on the general contractor’s bond.

In the Trane case, the general contractor had required a subcontractor payment bond. However, the general contractor’s bond form did not repeat the protective words in the statute that required the supplier to sue on the subcontractor bond instead of the general contractor bond. The Virginia Supreme Court held that the supplier could sue on the general contractor’s bond, stating that if the general contractor wanted the restrictive protection provided by the statute, the restrictive language must be repeated in the general contractor’s bond form.

It would seem that a court could reach the same decision today if a bond failed to include other restrictive protection allowed by the statute. We cannot be certain in any particular case, however, because courts have reached results that seem inconsistent. In another case, for example, the Virginia Supreme Court held that a claimant was still required to file suit within one year of its last work even though this restriction did not appear in the bond form.157 The bond explicitly identified a longer statute of limitations, but the court ruled that the Little Miller Act prohibited this term. Claimants should still argue that a bond form provides more protection that that required by statute. Bond principals should still be careful to avoid unnecessary exposure.

The Virginia Little Miller Act states, for example, that a supplier without a contract directly with the general contractor must provide notice of its claim within 180 days after the last supply of labor or material to the general contractor. Some bond forms do not discuss notice at all. A court could decide that no notice was necessary under such a bond form. The statute also extends protection only to “first and second tier” subcontractors. If these protective restrictions are not included in the bond form itself, a court may hold that a third or fourth tier supplier could sue on a general contractor’s bond. Some bond forms state that they are for the protection of “any person supplying labor or materials to the project,” without any restriction to those supplying the prime contractor and its subcontractors.

If the general contractor does not have the statutory protection, he could be placed in the position of paying a material supplier’s claim where (1) he has already paid the subcontractor for the materials; (2) the subcontractor has paid the sub-subcontractor; (3) the general contractor has required a subcontractor payment bond; (4) the general contractor has never heard of the materials supplier; and (5) the materials supplier has not provided any notice of its claim until a full year after the materials were supplied.

Bonding companies and general contractors should use a different bond form for each jurisdiction. Each bond form should provide for the minimum protection required and no more. It is very important that the general contractor’s bond form contains the protective wording of the statute.

On a public project, subcontractors and suppliers should always get a copy of the actual bond. The bond may provide for a greater period of time for notice, a longer statute of limitations or some other protection. Subcontractors may still have bond rights when they think they do not or when no bond coverage was required by statute.

It is sometimes necessary to convince a local municipality that its standard bond form unintentionally exposes general contractors to greater liability than is required by the applicable Miller Act. There is no doubt that the Act’s payment bond provisions are intended to protect those who supply labor and materials to public projects, even if a general contractor has to pay for the same labor and materials twice. While this possibility exists as a matter of public policy, the statutes also clearly intend to place some limits on this potential liability and provide the general contractor with some methods to protect itself.

Bond Forms on Private Projects

General contractors and bonding companies have an even greater opportunity to protect themselves on private projects. There is no law requiring any particular bond form. A general contractor is free to negotiate any bond form acceptable to the owner. Again, however, bonding companies and general contractors tend to use the same form that is used for all public projects. This exposes the bonding company and the general contractor to considerably more risk than necessary.

On private projects, provisions can be added that create extra “hurdles” for any potential claimant, including a shortened time for notice, requirements for dual notice to the principal and the bonding company, and a short statute of limitations for filing suit. This will reduce claims on the bond. Subcontractors, on the other hand, must get a copy of the bond on private projects, read it, and make sure they get over these extra hurdles.

Private owners are usually concerned only with exposure to mechanics liens and lawsuits. As long as an owner is indemnified against these risks, the owner usually doesn’t care how much protection is provided to lower tier subcontractors. The Virginia Mechanic’s Lien Law has a “Defense of Payment” provision where the general contractor only has to pay once for the project. Thus, if the general contractor can show that it has paid its subcontractors in full, then anyone claiming through that subcontractor will not be able to enforce a mechanic’s lien. The Miller Act payment bonds, however, do not have a defense of payment provision. A general contractor can be required to pay for the project more than once. There may be public policy reasons for this in the case of a Miller Act payment bond, but there is no reason for an owner or general contractor to pay twice on a private project.

A general contractor will want a private payment bond to have a defense of payment provision. The owner will also be satisfied with this situation because he is indemnified against any situation in which a claimant would have mechanic’s lien rights or any other claim against the property or owner.

Fullerton & Knowles has developed bond forms for owners, general contractors and sureties on private projects.

James D. Fullerton, Esq.
Clifton, VA
703-818-2600
www.FullertonLaw.com
COPYRIGHT (1997,2008) James D. Fullerton (703) 818-2600

Payment Bonds

INTRODUCTION

What Is a Bond?

Surety

Principal, Obligee and Obligor

Beneficiary

Types of Bonds

Payment Bond

Performance Bond

Bid Bond

Mechanic’s Lien Bond

BONDS ON PUBLIC PROJECTS—THE FEDERAL MILLER ACT

Miller Act Payment Bonds

Introduction

Possible Bond Claimants

Possible Bond Claims—Compensable Costs

Labor

Material

Rental Equipment

Material Not Actually Used

Delay and Constructive Change Costs

Interest and Attorney’s Fees

Notice Requirements for Claimants

Time Limits for Notice

Completion of Project and Claimant’s Last Work

Form of Notice

Recipients of Notice

Enforcement of Bond Claims

Time Limits for Enforcement

Parties and Claims in Enforcement Suit

Arbitration Clauses

Waiver of Payment Bond Rights

Getting Copies of Bonds

Miller Act Performance Bonds

Virginia Little Miller Act

Virginia Payment Bonds

Possible Bond Claimants

Subcontractor Bonds

Notice Requirements for Claimants

Enforcement of Bond Claims

Maryland Little Miller Act

Maryland Payment Bonds

Possible Bond Claimants

Notice Requirements for Claimants

Enforcement of Bond Claims

No Waiver in Subcontract

Pennsylvania Little Miller Act

Pennsylvania Payment Bonds

Possible Bond Claimants

Notice Requirements for Claimants

Enforcement of Bond Claims

Possible Bond Claims—Compensable Costs

Defense of Payment Under Pennsylvania Little Miller Act

District of Columbia Little Miller Act

Pitfalls for Subcontractors and Suppliers on Public Projects

No Bond Required

Insolvent Surety or Inadequate Security

Pitfalls for General Contractors on Public Projects

PRIVATE PAYMENT BONDS

BOND FORMS

Bond Forms on Public Projects

Bond Forms on Private Projects

Footnotes