Colorado Payment Bonds
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What Are They?
Payment bonds help ensure that subcontractors, suppliers, and workers are paid for their contributions to construction projects of all sizes. A Colorado payment bond is a contractor’s pledge to make such payments in accordance with the terms of the construction contract—on schedule and in the amount due. Cash flow issues are not unusual in the construction world, and payment bonds help make sure that paying subcontractors, suppliers, and workers is a priority so that work can continue without interruptions due to nonpayment. Parties who are not paid according to the terms of their contract can file a claim against the contractor’s Colorado payment bond and be compensated.
Who Needs Them?
Under Colorado’s Little Miller Act, contractors must provide a payment bond when awarded a state-funded construction contract valued in excess of $100,000. This is Colorado’s version of the Miller Act of 1935, which requires payment bonds from contractors awarded federally funded construction contracts. Private project owners today also often require payment bonds as a way to prevent mechanic’s liens from being filed by those who have not been paid by a contractor.
How Do They Work?
There are three parties to a Colorado surety bonds, known in the lingo of surety bonds as the obligee, the principal, and the surety. Each has different concerns, rights, and obligations.
- The obligee is the project owner requiring the bond. This could be a state agency funding a public works project or the owner of a private construction project. The obligee sets the required bond amount, or “penal sum,” which is the maximum amount paid to claimants.
- The principal is the contractor purchasing the payment bond and obligated to pay all valid claims.
- The surety is the bond’s guarantor. In guaranteeing the bond, the surety agrees to extend credit to the principal for the purpose of paying claims that the surety has investigated and found to be valid. The surety also establishes the premium rate the principal will pay when purchasing the bond.
The surety’s extension of credit to the principal takes the form of paying a valid claim on the principal’s behalf. That payment is a loan to the principal, not a gift, and must be repaid according to the terms of the surety bond agreement. The surety guarantees the principal’s payment of claims but is indemnified against any legal responsibility for the claims themselves. A principal who fails to repay the surety can be sued by the surety to recover the debt.
What Do They Cost?
Colorado payment bonds are sold for an annual premium determined by multiplying two factors: the bond’s penal sum and the premium rate. The penal sum reflects projected payments to subcontractors, suppliers, and workers. The premium rate is based on an underwriting assessment of the risk to the surety.
The primary risk is the risk of the surety not being repaid for claims paid on the principal’s behalf. Therefore, the principal’s personal credit score is the most commonly used metric for risk. The assumption is that a creditworthy principal will be financially responsible enough to pay the debt to the surety.
A high credit score is correlated with a low-risk level, which warrants a low premium rate. A low credit score means the risk level is higher, which warrants a higher premium rate.
A well-qualified principal typically will be assigned a premium rate in the range of 0.5 to 3 percent.
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