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What Are Arkansas Payment Bonds?
Construction contracts contain provisions governing the payment of subcontractors and suppliers. Including the payment schedule in a contract provides assurance that those who contribute labor and materials are paid a certain amount by the prime contractor upon the achievement of specific project milestones. Not meeting such payment obligations can result in the project owner’s property being encumbered with mechanic’s liens.
Arkansas payment bonds ensure that unpaid subcontractors and suppliers receive the money owed to them without financial harm to the project owner (the bond’s “obligee”) by legally obligating the contractor (the bond’s “principal”) to pay valid claims filed by the injured parties.
Who Needs Them?
Arkansas’s “Little Miller Act,” the state’s version of the federal Miller Act, is set forth in Title 19, Chapter 11, subchapter 2 of the Annotated Arkansas Code. It requires a payment bond for every construction project valued in excess of $20,000 funded by the state or any of its political subdivisions. The payment bond must be in an amount equal to the contract value. No contractor can enter into a public works contract without furnishing the necessary payment bond.
Private construction projects are not subject to the Arkansas Little Miller Act. However, private project owners often require payment bonds, especially for larger contracts, as protection against mechanic’s liens.
How Do Arkansas Payment Bonds Work?
An Arkansas payment bond is legally binding on three parties: the obligee, the principal, and the bond’s guarantor (the “surety”). While the principal is legally obligated to pay valid claims, the surety verifies their validity and guarantees that they will be paid. That guarantee is in the form of an agreement to lend the principal the necessary funds to pay a claim up to the full bond amount.
The actual practice is for the surety to pay the claimant directly on behalf of the principal. The principal then repays the resulting debt according to the surety’s credit terms. Failure to do so is likely to lead to the surety taking legal action to recover the funds.
How Much Do They Cost?
Payment bonds are sold for a premium that is only a small percentage of the required bond amount. The obligee establishes the bond amount, and the surety assigns a premium rate that reflects the risk to the surety. Multiplying these two factors gives you the premium cost of your payment bond.
In setting the premium rate, the surety’s greatest concern is credit risk—the risk of not being repaid for the credit extended to the principal in paying a claim. The principal’s personal credit score is the accepted measure of credit risk.
A high credit score is correlated with low risk, which merits a low premium rate. However, a low credit score calls for a higher premium rate to offset the greater credit risk.
A well-qualified principal typically will be assigned a premium rate in the range of .5% to 3%.
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