How Bonded Principals Respond to Labor & Material Payment Bond Claims

A surety bond is a three-party contract between the Surety, the Principal, and the Obligee. The Surety is the party that issues the Performance Bond along with the Labor and Material Payment Bond, which promises to answer for the default of the second party—its Principal. The Principal, in many cases, is a General Contractor. Typically, a Surety will become aware of any project problems when claims are made against the Payment Bond. This includes allegations of unpaid subcontractors and material suppliers.

Upon receipt of a claim, the Surety will begin an investigation. As part of its investigation, the Surety will consult with its Principal to determine whether they are keeping up with their payment obligations. For example, if the Surety finds that the Principal is experiencing cash flow problems, they know that often leads to slow or nonpayment of subcontractors and material suppliers.

What is a Proof of Claim (POC) Form?

Upon receipt of a claim notice, the Surety will forward a Proof of Claim form (POC) to the claimant and request they execute and notarize the form.  In addition, the Surety will request documentation from the claimant to support its claim and return them to the Surety. The Surety will forward the POC and the claimant’s information to its Principal, request they respond to the claim, and provide the Surety with documentation to support its position. Subsequently, to receiving its Principal’s response, the Surety will then submit the response to the claimant and request they respond to the Principal’s position. 

At that point, the Surety will review the claimant’s and Principal’s positions and documentation. It is the Surety’s legal obligation to conduct an independent, objective investigation in order to determine the validity of the claim. The Surety may require assistance to analyze the claim such as a professional engineer, a registered architect, or a CPA. However, the Surety’s claims professional makes the ultimate decision as to the validity of the claim is.

Understanding the role of a General Indemnity Agreement (GIA)

The Principal should understand that any costs incurred by the Surety for professional services in order to investigate the claim are the responsibility of the Principal and its Indemnitors under the General Indemnity Agreement (GIA). The GIA requires the Principal and/or their Indemnitors to reimburse the Surety for any losses it incurs.      

The Surety must respond to the claimant regarding the validity of the claim within a certain time. The time can be determined by language in the Payment Bond, a state or federal statute, or any other governmental requirement. Therefore, it is imperative the Principal responds quickly to the Surety with its position and documentation. Otherwise, the Principal’s failure to respond timely to its Surety may cause the Surety to miss the deadline to respond to the claimant. In such an event, that claim is deemed to be valid in whole. This means the Surety or the Principal must make payment of the entire amount claimed by the claimant.

How the Surety responds to the claimant

Upon completion of its independent investigation, the Surety has options regarding the response it needs to provide to the claimant:

1. The Surety may determine the claim is valid in whole or in part. In that case, the Surety will request the Principal and/or its Indemnitors under the GIA make payment to the claimant in the amount the Surety has determined is validly due and owing. If the Principal or their Indemnitors do not make payment to the claimant, the Surety will make the payment and request reimbursement under the GIA from their Principal and/or their Indemnitors.
   
   
2. The Surety may determine the claimant’s documentation is incomplete or deficient in order to substantiate the validity of its claim. If this is the case, the Surety will deny the claim on the basis that the claimant’s submission did not provide sufficient information to determine the validity of the claim.
   
   
3. The Surety may determine that each party has provided documentation to substantiate their respective positions. Under this scenario, the Surety may deny the claim because of a bona fide dispute. It is important to note, the Surety does not act as judge and jury. The Surety serves to determine the validity of a claim. Bona fide disputes are resolved by way of a dispute resolution forum such as litigation, arbitration, etc. which may be provided for in the contract.

What happens when Payment Bond claims become numerous?

In situations where Payment Bond claims are becoming numerous, the Surety will typically do a full assessment of its different options in order to mitigate future losses. Another option may involve providing the Principal with additional financing. In this manner, the surety can avoid additional Payment Bond claims and the possible imposition of mechanic’s liens against the project.

It is imperative to remember, any loss incurred by the Surety because of claims against the Bonds is the ultimate responsibility of the Principal and/or its Indemnitors under the GIA. The takeaways for a Bonded Principal in order to avoid causing the Surety a loss from Payment Bond claims are:     

• Having adequate financial controls in place is a must to avoid cash flow problems which may lead to Payment Bond claims
• Maintaining a complete and accurate project file in order to substantiate its position if needed to respond to Payment Bond claims
• Providing a timely response to the Surety upon receipt of a Payment Bond claim

While a Principal or Surety cannot control the fling of a claim or the number of claims filed against the Bonds, the Principal must be ready to respond to them—within a timely fashion—complete and accurate documentation.

If you have additional questions regarding payment bond claims or any other bond questions, contact TSIB today!

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