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Labour and Material Payment Bonds
VALUE ADDED FOR SUBS, OWNERS AND GENERALS
Construction purchasers seeking to protect themselves from the perils of contractor default should require that the contractor provide two surety bonds:
- a performance bond to guarantee that the contractor will carry out the work in accordance with the terms of the contract; and
- a labour and material payment bond to guarantee that direct subcontractors and suppliers will be paid for materials/services provided to the job.
The Surety Association of Canada has found that most construction purchasers, particularly those in the public sector are well aware of the advantages offered by performance bonds and have no hesitation in asking for them from the contractors whose services they engage. With labour and material payment bonds however, the benefits to owners are often misunderstood. In fact we often encounter construction purchasers who resist calling for these bonds on the grounds that they don't perceive any value to them. A typical objection runs something like this: "Why should I ask for payment bonds when these are for the benefit of subs and suppliers and do nothing for owners. Besides, subs are protected by the holdback provisions in the various provincial lien acts. Why do they need any more than that?"
We suggest that this approach is not only unduly harsh and insensitive to the plight of labour and material suppliers, but is short-sighted business practice as well. In the event of a construction default, the protection offered to suppliers by lien legislation will be their pro-rata share of the holdback (typically 10% of the contract value ). With that, we offer two sobering statistics for owners (to say nothing of subs and suppliers):
Since the beginning of this decade, the average loss to a surety on a bonded default was 40% of contract value.
Over that same period, approximately 70% of all contract bond losses have been paid out under the payment bond.
You don't need a calculator to conclude that the 10% "protection" of the holdback will typically amount to pennies on the dollar.
Having said that, what's in it for the owners? We still hear from disgruntled purchasers who object to footing the bill for payment bonds while the subs derive all the benefits. It's not as simple as that. True, payments made under labour and material payment bonds are not made by a cheque payable to the owner but is that really the end of the story? We submit that there are real benefits both direct and indirect to owners, particularly public bodies in guaranteeing that subs and suppliers are paid 100 cents on the dollar.
Four reasons to require L & M Bonds in your construction specs;
1) Moral Obligation
The ethical responsibility of an owner is to ensure that all suppliers of material and services on their jobs are paid 100 cents on the dollar. While it may sound sanctimonious, this is particularly relevant to public owners who rightly or wrongly are held to a higher level of accountability. For public bodies as well, this moral obligation can turn into a thorny political problem particularly at the municipal level should an unpaid trade be a local ratepayer.
2) Ease of Administrative Burden
In the event of a prime contractor default, owners and/or their representatives will be called upon to deal with subs and suppliers and assess the merit of their claims. This can be a horrendous administrative burden as owners can find themselves deluged with phone calls from hundreds of irate subs demanding satisfaction. There is also the legal risk and expense involved in ensuring that the holdback monies unpaid draws are dealt with and disbursed in a proper manner.
With a labour and material payment bond, this responsibility is now handed over to the bonding company. The owner is no longer forced to provide the administrative staff to deal with the claims of subs and suppliers (regardless of the merit of these claims).
3) Savings to the Owner
Construction is a very risky and volatile class of business and even in good times millions of dollars are written off as bad debts by subs and suppliers. Many of the more sophisticated subs have been burned too often and are now keenly aware of the owners who require payment bonds and those who do not. A number of high profile suppliers have indicated to us that they will add a risk fee on their price where no labour and material payment bond is in place. These risk fees will invariably be passed onto the owner.
4) More Expeditious Handling of Performance Bond Claims
One final reason for any construction purchaser, public or private to consider payment bonds is the ramifications it may have for both the surety and the owner in the event of a claim under the performance bond. When a surety has only a performance bond on a job, its obligation is limited to the completion of the work under the contract. This can create a significant problem in the event that a defaulted contractor has left trades unpaid, as is invariably the case. These subs and suppliers typically will refuse to return to a job unless they are guaranteed payment for work already performed. Given that the surety is not obligated to make any such guarantee, they must then contract with replacement subcontractors which will add significantly to the time required to complete the contract. With a labour & material payment bond in place, the surety will be in a position to make the required guarantees to trades thus ensuring continuity on the job and a more timely completion
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