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What Are Indiana Payment Bonds?
The purpose of an Indiana payment bond is to prevent the encumbrance of a construction project owner’s property with mechanic’s liens if a contractor fails to pay subcontractors and suppliers for the labor or material they have provided. Payment bonds incentivize contractors to adhere to contractual payment requirements. They also give unpaid subcontractors and suppliers a mechanism for obtaining the money they are owed without the use of mechanic’s liens.
Who Needs Them?
Indiana’s “Little Miller Act,” the state’s version of the federal Miller Act, can be found in Indiana Code, Title 5, Article 16, Chapter 1. It requires contractors to provide a payment bond before they can enter into a public works contract valued in excess of $200,000. The amount of the payment bond must be equal to 100% of the contract value.
The statutory requirement for payment bonds does not apply to private construction projects. But without them, private project owners are at risk of having mechanic’s liens placed on their property when subcontractors and suppliers are not paid properly. Consequently, it’s not uncommon for private project owners to require payment bonds from the contractors they hire.
How Do Indiana Payment Bonds Work?
An Indiana payment bond is a legally binding agreement among three parties, known in surety bond lingo as:
- the “obligee” (the project owner requiring the bond),
- the “principal” (the contractor purchasing the bond), and
- the “surety” (the bond’s guarantor)
When a claim is submitted, the surety will determine whether it is valid. If it is, the principal is legally obligated to pay it. However, the surety, in the role of guarantor, has agreed to furnish the funds to do so as an extension of credit to the principal. But the surety doesn’t simply hand the money over to the principal. Instead, the surety pays the claim on behalf of the principal and gives the principal some time to repay the resulting debt. Failing to repay the debt in accordance with the surety’s credit terms will most likely cause the surety to take legal action to recover the funds.
How Much Do They Cost?
Indiana payment bonds are sold for a premium that is calculated by multiplying the bond amount (set by the obligee) by the premium rate (assigned by the surety). The bond amount is based on the value of the construction contract, while the premium rate is based on the surety’s underwriting assessment of the credit risk of a lender not being repaid by a borrower. Credit risk is measured by the principal’s personal credit score.
The higher the principal’s credit score, the lower the risk and the lower the premium rate. A lower credit score is a red flag for credit risk, which calls for a higher premium rate to offset it.
A well-qualified principal typically will be assigned a premium rate in the range of .5% to 3%.
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