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What Are Kentucky Payment Bonds?
A Kentucky payment bond is a form of surety bond that can prevent the encumbrance of a property by mechanic’s liens when a contractor fails to pay subcontractors or suppliers. A payment bond provides financial protection for both the project owner (the bond’s “obligee”) and those who contribute labor and materials to a construction project. The bond legally obligates the contractor (the bond’s “principal”) to pay valid claims filed by unpaid subcontractors and suppliers. The obligee’s property remains unencumbered, and the subcontractors and suppliers get the money they are owed.
Who Needs Them?
Kentucky’s “Little Miller Act” is the state’s version of the federal Miller Act and can be found in the Kentucky Revised Statutes, Chapter 45A. It mandates payment bonds from contractors selected for state-funded projects valued in excess of $40,000. Purchasing a payment bond is a prerequisite for entering into a contract with the state or one of its political subdivisions. The amount of the payment bond must be equal to the full contract value.
Private project owners don’t have the advantages that the Little Miller Act gives the state of Kentucky. But private project owners (and their investors, if any) also want protection against mechanic’s liens. Consequently, many of them choose to require payment bonds from the contractors they hire.
How Do Kentucky Payment Bonds Work?
Every Kentucky payment bond is a legally binding contract among three parties: the obligee, the principal, and a third party known as the “surety.” This is the party that guarantees the bond—specifically guaranteeing the payment of claims.
But the legal obligation to pay valid claims belongs entirely to the principal. The surety’s guarantee actually is an agreement to lend the principal the funds to pay valid claims, if that becomes necessary.
Here’s what that looks like in practice. Upon receiving a claim against a payment bond, the surety will investigate to determine that it’s legitimate and must be paid. The surety will then pay the claim on the principal’s behalf as an extension of credit that must subsequently be repaid in accordance with the surety’s credit terms. Not repaying that debt is likely to lead to the surety taking legal action against the principal to recover the funds.
How Much Do They Cost?
The premium for a Kentucky payment bond is a small percentage of the required bond amount. That percentage, the premium rate, is set by the surety to reflect the risk of extending credit to the principal. The risk, of course, is that the surety won’t be repaid for claims paid on the principal’s behalf. Underwriters use the principal’s personal credit score as the primary measure of this risk.
It’s safe to assume that someone with a high credit score presents little risk to the surety, which merits a low premium rate. However, extending credit to someone with a low credit score carries higher risk, warranting a higher premium rate.
A well-qualified principal typically will be assigned a premium rate in the range of .5% to 3%.
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