What Are Tennessee Payment Bonds?
Tennessee payment bonds represent a crucial strategy for protecting construction project owners against the financial fallout that can occur when contractors fail to pay subcontractors and/or suppliers as required. The project owner (the bond’s “obligee”) gains protection against mechanic’s liens on the property, as the bond provides another way for unpaid subcontractors and suppliers to obtain the money due to them. Specifically, a payment bond legally obligates the contractor (the “principal”) to pay valid claims. And a third party (the “surety”) guarantees the payment of valid claims.
Who Needs Them?
All states have their own versions of the federal Miller Act of 1935, which requires both payment and performance bonds for federally-funded construction projects that meet certain criteria. Tennessee’s Little Miller Act is outlined in the Tennessee Code Annotated, particularly Sections 12-4-201 to 12-4-205. It requires contractors to furnish payment bonds before entering into a public works contract valued in excess of $100,000. The payment bond must be in an amount equal to 100% of the contract value.
The obligee will let you know whether you must furnish a payment bond and, if so, in what amount. If you do have to provide the obligee with a payment bond, it must be in place before work on the project can begin.
Tennessee’s Little Miller Act does not apply to privately funded construction projects. Nevertheless, many private project owners want the same protection that is mandated for comparable public works projects and, therefore, require the contractors they hire to furnish payment bonds.
How Do Tennessee Payment Bonds Work?
At the heart of the payment bond agreement is the explicit guarantee that the obligee will extend credit to the principal if that’s what it takes to pay a valid claim. That doesn’t mean the obligee issues a check to the principal. The usual practice is for the surety to pay the claim on the principal’s behalf, to be repaid later, often in installments, according to the surety’s credit terms. Not repaying the debt is likely to result in the surety taking legal action against the principal to recover the funds.
How Much Do They Cost?
What a given contractor will pay for a Tennessee payment bond depends on the required bond amount and the premium rate. The bond amount is tied to the contract price. And the surety assigns a high enough premium rate to offset the risk of not being repaid for paying a claim on the principal’s behalf. The underwriters measure that risk using the principal’s personal credit score.
An individual with a high credit score is deemed financially responsible and a low risk to the surety.
Therefore, a low premium rate is appropriate. But a low credit score raises red flags, which calls for a higher premium rate to offset the elevated risk.
A well-qualified principal typically will be assigned a premium rate in the range of .5% to 3%.
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