By Jones Osborn II

Construction projects are often "bonded." The purpose of a bond is to protect the owner if the contractor suffers financial difficulties which interferes with the completion of the project or if the contractor is otherwise unable to carry out the terms of its contract.

Types of Bonds. There are basically two types of construction bonds--performance bonds and payment bonds. Both are generally purchased before construction starts, but they cover distinctly different risks.

A performance bond, sometimes referred to as a completion bond, insures that the contractor will complete the project, and will do so for the amount set forth in the contract. Thus, if the contractor defaults the bonding company will either hire another contractor to complete the contract or will provide the money necessary to cure the default. This protects the owner against a contractor who goes bankrupt or otherwise abandons a project in mid-stream, leaving the owner with a very expensive and messy problem. A performance bond clearly provides a great deal of protection to the owner, but such bonds are expensive, adding to the cost of the project. In addition, not every contractor is bondable, because bonding companies generally will bond only companies with a strong financial statement and a proven operating history.

A payment bond insures that that the subcontractors and suppliers of material and equipment will be paid, thereby providing protection against mechanics' and materialmen's liens. Thus, if the general contractor fails to pay one of his subcontractors, the bonding company will make the payment so that the subcontractor does not file a lien against the project. This prevents the project from grinding to a halt when liens start to pile up because the general contractor is not paying his subcontractors and suppliers. It also protects the owner's equity in the project which can be lost if the liens are not paid.

There is a variant of the payment bond which can be obtained after a lien has been filed. Under Arizona law, a mechanics' and materialmen's lien can be discharged by filing a bond equal to one and one-half the amount claimed by the lien. This allows the property to be cleared of the lien while the parties sort out any disagreements relating to the lien, such as whether the work was properly performed and whether the amount claimed is proper. This type of bond does not protect the property from all liens, only from the particular lien that is bonded against.

Wording of the Bond. The courts have made it clear that the language of the bond itself governs the coverage offered by the bond, regardless of what the bond is called. One must carefully read the language of the bond, which is really nothing more than a contract between the owner and the bonding company, to determine the types of claims that are covered and the type of protection the owner is to receive.

For example, in one Arizona case, the language in a payment bond stated that it covered only those who had a "direct contract" with a particular air conditioning subcontractor. When the general contractor hired another subcontractor to complete the air conditioning work after the original subcontractor was unable to, the court held that the new subcontractor was not covered by the language of the bond and that the general contractor was not entitled to coverage against the claims of the new subcontractor. This was because the new subcontractor did not have a "direct contract" with the original air conditioning subcontractor; instead, its contract was with the general contractor. Therefore, it is necessary to carefully read the language of the bond to be sure the necessary coverage is provided.

Conclusion. Bonds can furnish considerable protection to anyone hiring a contractor for a construction project. However, they do increase the cost, and it is necessary to carefully review the language of the bond to determine exactly what protection is offered. All bonds are not the same, and it is important to obtain the precise protection that is needed for the particular project. In cases where a bond is appropriate, it may be advisable to obtain both payment and performance bonds, or a single bond which covers both types of claims.

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A.R.S. Sec. 33-1003, -1004; American Casualty Co. v. D.S. Withers Constr. Co., 204 Ariz. 282, 64 P.3d, 210 (Ariz. App. 2003).