Surety bonds in Florida are subject to claims even if the claimant has agreed to a valid pay-if-paid clause in its contract with the principal. Sureties should still require principals to include pay-if-paid clauses in their contracts, despite the protection it affords the principal, even if the surety is not protected. The surety can only be protected by the pay-if-paid clause if it has issued a “Conditional Payment Bond” that complies with Florida law.
“Pay-if-paid” or “conditional payment” clauses excuse the general contractor (principal) from paying its subcontractor (claimant) unless the general contractor has been paid by the owner. To be valid, the pay-if-paid clause must be clear that the general contractor is not obligated to pay subcontractors unless and until the owner pays the general contractor. The contract should also inform the subcontractor that this protection will be extended to the general contractor’s surety. The following is an example of an enforceable pay-if-paid clause that sureties should require principals to use in their subcontracts:
Subcontractor expressly agrees that payments by owner to contractor for any work performed by subcontractor is an express condition precedent to any payment by contractor to subcontractor and that contractor is under no obligation to make any partial, final or retainage payments to subcontractor until and unless contractor has been paid by owner. Subcontractor further agrees that the liability of the surety on contractor’s payment bond, if any, for payment to subcontractor is subject to the same conditions precedent as are applicable to contractor’s liability for payment to subcontractor. Subcontractor’s agreement to this “pay if paid” provision is a material inducement to contractor’s entering into this Agreement. Subcontractor agrees that in the event contractor is required to post a payment bond, that payment to subcontractor and/or to any sub-trade of the subcontractor shall be expressly contingent upon the prior payment by the owner, and waives all claims against the contractor’s bond to the extent that payment has not been received by owner. Most important however—despite the inclusion of a valid pay-if-paid clause, it will not eliminate the surety’s obligation to pay subcontractors claims against surety bonds unless they are “conditional payment bonds.”
Requirements of Conditional Payment Bonds in Florida
Strict compliance with Florida law is required to issue a valid conditional payment bond. The requirements of a conditional payment bond include: (a) attaching a copy of the bond to the recorded notice of commencement before work begins on the project; (b) identifying the bond as a conditional payment bond within the notice of commencement; (c) including the words “conditional payment bond” in the title of the bond at the top of the first page of the bond; and (d) including certain disclosure language on the front page of the bond in at least 10 point font. Failure to meet any of the required conditions will prevent the creation of a valid conditional bond. If the bond fails to meet the requirements to make it conditional, it will be considered unconditional, in which case, subcontractors, sub-subcontractors and suppliers may assert claims against the surety even if the principal’s contract contains a valid pay-if-paid clause regardless of whether the owner has paid the general contractor.
Conditional payment bonds, as opposed to unconditional surety bonds, do not exempt the owner’s property from liens. Because both the general contractor’s and surety’s obligations under a conditional payment bond are contingent upon payment by the owner, the law allows subcontractors to file a lien against the owner’s property. If the general contractor has accepted payment from the owner on account of the lienor’s work, the recorded lien transfers to a claim on the conditional bond. However, if the owner has not paid the general contractor for the lienor’s work, the lienor’s claim is against the owner and its property only.
The problem from the surety’s standpoint is that owners must agree to a conditional payment bond to take advantage of the protection provided. Most owners refuse, as the point of requiring a payment bond in the first place is to ensure that the property remains clear of any liens. As a result, conditional payment bonds are relatively uncommon, and sureties are typically called on to issue unconditional surety bonds.
Regardless of the fact that a pay-if-paid clause does not legally protect the surety from claims even if the owner has not paid the principal, we still recommend that the surety require its principal to include the pay-if-paid contract language in its subcontracts. Many subcontractors (and even lawyers) are not well versed in the technical requirements related to liens and claims against surety bonds. Often, a subcontractor or his lawyer finding this language in its contract may wrongly believe that it has no claim against the surety even if the surety has issued an unconditional payment bond. As a result, the subcontractor may unwittingly waive its surety bond rights by failing to comply with relevant claim and filing deadlines. In short, requiring strict contractual language in your principal’s subcontracts may provide a practical layer of protection in some circumstances, despite it providing no actual legal protection.
The Surety Should Exercise its Right to Settle a Claim
Pay-if-paid clauses can become a source of dispute between the principal and the surety when the surety has issued an unconditional payment bond. Principals will want to rely upon their contractual pay-if-paid clauses to avoid payment to subcontractors. On the other hand, the surety who is liable regardless of the lack of payment from the owner, may be better off paying the subcontractor’s claim to avoid additional costs, fees and interest. Many subcontractors only pursue the bond in these situations to circumvent the pay-if-paid clause and leverage the principal and surety for payment.
When this occurs, principals often seek to continue to delay payment to the claimant despite the surety’s clear obligation to pay. This request is understandable as the principal, through operation of its indemnity agreement with the surety, is suddenly subject to a claim from its subcontractor it believed it was protected against by virtue of the pay-if-paid clause. However, abiding by the principal’s request to delay payment will result in unnecessary legal and administrative costs to the surety and an increased cost of settlement with the claimant. As a result, the surety should exercise its right to settle valid claims instead of delaying payment at its principal’s request, and pursue the principal for indemnity.
The Authors of the foregoing analysis and opinion, Bruce E. Loren and Kyle W. Ohlenschlaeger of the Loren & Kean Law Firm are Surety One, Inc. endorsed subject matter experts on surety bonds, and claims. The firm and its partners specialize in construction law, employment law, and complex commercial litigation. Mr. Ohlenschlaeger focuses his practice on construction law and a wide range of commercial litigation disputes. Mr. Loren has achieved the title of “Certified in Construction Law” by the Florida Bar, exemplifying the Bar’s recognition of this expertise. Mr. Loren and Mr. Ohlenschlaeger can be reached at email@example.com or firstname.lastname@example.org or (561) 615-5701. National surety bond leader, Surety One, Inc. underwrites contract surety bonds for public, private and P3 projects throughout the State of Florida.