Payment bond definition: A payment bond is a surety bond issued to contractors that guarantees that the contractor will pay their subcontractors, material suppliers, and laborers in a timely fashion.
Payment bonds are usually obtained by contractors or subcontractors prior to the commencement of a construction project. Their function is to guarantee that the labor and materials provided by subcontractors and suppliers to a general contractor will be paid for in due time and in compliance with the contract. These bonds also guarantee that payments for labor and material will comply with state and federal laws and regulations.
Payment bonds serve as protection for subcontractors, and offer them legal recourse against contractors who do not fulfill their side of the contract terms. If a contractor has failed to pay subcontractors, suppliers and laborers can file a claim against the payment bond within a certain period of time, and receive compensation by the surety.
In other words, payment bonds are an agreement between the obligee requesting the bond (the subcontractor, supplier or laborer), the principal who obtains the bond (the contractor) and the surety bond company underwriting the bond.
Once a claim is initiated, the surety investigates, in order to decide whether any action must be taken. If the claim is legitimate, obligees can expect to be compensated for their losses up to the full amount of the payment surety bond.
If such compensations are made, principals– i.e. contractors– must compensate the surety for its coverage of the payment bond claim. That’s why contractors should always strive to avoid claims, and seek solutions to problems before they escalate.