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What Are Arizona Payment Bonds?
Without a payment bond, project owners could have their property encumbered by mechanic’s liens if their contractor fails to pay subcontractors or suppliers. Instead, a subcontractor or supplier that has not been paid must file a claim against the payment bond the project owner (known as the “principal”) has furnished the project owner (the bond’s “obligee”). The payment bond legally obligates the principal to pay all valid claims filed by unpaid subcontractors or suppliers within a certain time period following project completion.
Who Needs Them?
Arizona’s “Little Miller Act,” the state’s version of the federal Miller Act, is found in the Arizona Revised Statutes, Title 34, Chapter 2, “Bonds on Public Works Contracts.” It requires contractors to furnish a payment bond in order to take on any state-funded construction project. The bond must be in an amount equal to 100% of the project value.
The state’s Little Miller Act doesn’t apply to privately funded construction projects. However, it’s fairly common for private project owners to require payment bonds from contractors to protect the property against mechanic’s liens.
How Do Arizona Payment Bonds Work?
There are three parties to an Arizona payment bond: the obligee, the principal, and the bond’s guarantor (called the “surety”). The surety guarantees the payment of valid claims by agreeing to extend credit to the principal for that purpose if necessary.
The surety investigates every claim received and confirms its validity before paying it on the principal’s behalf. That payment, drawn against the line of credit established for the principal when the payment bond was purchased, creates a debt that the principal is legally obligated to repay in accordance with the surety’s credit terms. The surety can take legal action to recover the funds if the principal fails to repay the debt.
How Much Do They Cost?
Multiplying the bond amount by the premium rate yields the premium cost of an Arizona payment bond. The obligee establishes the required bond amount, but the surety sets the premium rate through underwriting. The primary underwriting concern is credit risk, which is the risk of the principal not repaying the surety for the credit extended in paying a claim. The standard measure of credit risk is the principal’s personal credit score.
A principal with a high credit score presents little credit risk and deserves a low premium rate. However, a principal with a low credit score will be assigned a higher premium rate to offset the elevated credit risk.
A well-qualified principal typically will be assigned a premium rate in the range of .5% to 3%.
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