UTILITY CONSTRUCTION SURETY BONDS, PART 2--PAYMENT BONDS

A performance bond is intended to assure a utility that a contractor will complete a contract according to its terms. A payment bond is intended to assure a utility that the contractor's labor subcontractors, and material and equipment suppliers, will be paid what is owed them by the contractor.

A payment bond can offer subcontractors an alternative to enforcement of mechanics liens. In some jurisdictions, a subcontractor on a public works project for a municipal-owned utility can assert a mechanics lien only against unspent funds held by the owner for that project. Thus, under some circumstances, subcontractor claims may exceed available funds held by a utility for the project.

Things may not be that much better in the case of an investor-owned utility. Several years ago, a contractor unpaid for work done on a component of a wastewater treatment plant foreclosed on a mechanics lien on the plant and acquired a partial ownership interest in the plant. The state utilities commission then cited the contractor for alleged violation of utility law requiring a certificate of public convenience and necessity as a regulated public utility.

When a contractor fails to pay subcontractors, claims for payment can be made against the surety on a payment bond. However, there are notice requirements in such a bond that must be followed. If a surety does not pay subcontractor claims, generally both the utility owner and affected subcontractors may sue the surety. However, a surety, as in the case of performance bonds, may assert defenses to liability. Thus, again, the bond can simply become a ticket to admission to a courthouse trial. The amount of a bond, of course, is the limit of a surety's financial obligation in any case.

A recent court decision addressed a situation where a contract between a municipality and a contractor for a public works project required the contractor to produce both a performance bond and a payment bond. However, the contractor failed to provide the required payment bond. The court held that an unpaid subcontractor was a third party beneficiary of the municipality's agreement with the contractor requiring the contractor to supply a payment bond. Accordingly, the court held that the subcontractor could sue the municipality for breach of contract and recover from the municipality payment for its work. (Lake County Grading Company, LLC v. Village of Antioch, 2013 IL.App.(2d)120474 (2nd Dist.)).

In short, it would seem prudent, and in some cases a legal requirement, for a utility to require its contractors to produce both performance and payment bonds, in adequate dollar amounts and issued by approved sureties.