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What Are Washington Payment Bonds?
Construction contracts stipulate how much and when subcontractors and suppliers are to be paid by the prime contractor. When contractors do not live up to their payment obligations, the project owner’s property can end up being encumbered with mechanic’s liens. Payment bonds are intended to prevent this and ensure that those who provide labor and materials are compensated.
A payment bond provides financial protection for the project owner (the bond’s “obligee”), and legally obligates the contractor (the bond’s “principal”) to pay valid claims filed by unpaid subcontractors or suppliers.
Who Needs Them?
The formal name of Washington’s “Little Miller Act,” the state’s version of the federal Miller Act, is the Washington State Public Works Act. You can find the relevant text in Chapter 39.08 of Washington’s Revised Code.
This legislation requires payment bonds from contractors before they can enter into a contract for a state-funded construction project with an estimated value above $35,000. Every payment bond must be for a dollar amount equal to 100% of the project’s value.
Contractors selected for private construction projects are not required by law to furnish a payment bond. However, many private project owners make the purchase of a payment bond a prerequisite for being awarded a contract.
How Do Washington Payment Bonds Work?
There is a third party to a Washington payment bond, in addition to the obligee and the principal—the bond’s guarantor (called the “surety”). The surety guarantees the payment of valid claims by agreeing to extend sufficient credit to the principal to cover the claim up to the full bond amount.
In fact, the surety will pay the claim initially on the principal’s behalf. The principal is legally obligated to pay back that “loan” according to the surety’s credit terms. If the principal does not repay the debt to the surety in full, the surety can initiate a lawsuit to recover the funds.
How Much Do They Cost?
Payment bonds are affordable, costing the principal a small percentage of the required bond amount. The obligee establishes that amount, while the surety assigns the premium rate on a case-by-case basis. Multiplying the two figures gives you the premium amount the principal will pay for the bond.
The surety’s main concern in setting an appropriate premium rate is the credit risk to the surety—the risk of not being repaid for the credit extended to the principal. The universally accepted measure of credit risk is the principal’s personal credit score.
A person with a high credit score is viewed as a low risk, which should result in a low premium rate. However, someone with a low credit score presents greater credit risk, which 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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