Currently every state but New Hampshire has enacted a prompt pay statute for public construction projects, and about one-third of the states have enacted a similar prompt pay statute for private projects. These prompt pay statutes have their beginnings in the Federal Prompt Payment Act which became the law applicable to federal public construction nearly 30 years ago.[1] Basically, the Federal Prompt Payment Act requires the owner/government to pay the general contractor within 14 days of a payment application being submitted. If the payment application is for final payment on the project, it is due 30 days after final acceptance by the owner and submittal of the final invoice. In addition, the Federal Prompt Payment Act directs that payments to first tier subcontractors occur within 7 days following receipt of payment by the general contractor from the owner. While states’ Prompt Payment Acts differ from the Federal Prompt Payment Act and from each other in certain respects, all of these statutory schemes follow the same general pattern.

Why are Prompt Payment Acts important to a surety? Primarily because the owner’s (or, in the case when payment is due to a subcontractor, the general contractor’s) failure to pay in accordance with the applicable Prompt Payment Act is deemed a breach of contract, and that may lead to a full defense for the surety on a performance bond claim. A material breach by an owner/obligee of the underlying bonded contract has long been recognized as a defense to a performance bond claim. See, Gelinas and Teich, Chapter 11 entitled “Defenses Available To The Surety,” The Law of Performance Bonds, 2nd Ed. (2009); American Law Institute, Restatement of the Law of Suretyship and Guaranty, Third, § 19 (1996). One of the clearest examples of material breach is when an owner has failed to pay a progress draw to a contractor. The owner’s failure to pay is generally considered a material breach which relieves the non-breaching party (contractor) of its contractual obligation, which in turn also relieves the surety of its obligation on the performance bond. See, e.g., Brady Brick & Supply Co. v. Lotito, 43 Ill. App. 3d 69, 356 N.E.2d 1126 (Ill. App. 1976) (failure to pay installment of contract price is a substantial breach of contract and gives the contractor the right to consider the contract at an end, to cease work, and to recover value of the work already performed); Bank of Brewton, Inc. v. International Fidelity Insurance Co., 827 So. 2d. 747 (Ala. 2002) (failure to make payment to contractor and failure to follow contract’s default procedures resulted in surety not being liable on performance bond).

The most prevalent performance bond form used in the surety industry, the American Institute of Architects (“AIA”) A312 bond form, expressly recognizes this surety defense when there is a failure by the owner/obligee to comply within the underlying bonded contract. Contained within the two versions of the A312 performance bond (issued by the AIA in 1984 and 2010) are provisions that predicate any performance by the surety on the absence of default by the owner/obligee. If the owner/obligee has defaulted, it will relieve the surety of any obligation to fulfill the demands of the owner/obligee under the A312 performance bond.

The reality is that while Prompt Payment Acts are well intended and serve a useful purpose by requiring timely payment to contractors who have performed work on projects, these laws are also traps for the unwary. When parties get into a dispute, the tendency of the paying party is often to withhold payment until the dispute has been resolved. While this may be an effective bargaining tactic in many pre-litigation settings (“he who has the gold rules”), the result will be disastrous for a party whose withholding violates the applicable Prompt Payment Act. That party’s breach of the Prompt Payment Act is tantamount to a breach of the bonded contract, which causes that party to lose all contract rights against the non-breaching contractor/principal and to lose all bond rights against the surety. Regardless of whether the violation of the Prompt Payment Act was a willful or unknowing act by the owner/obligee, the surety can assert a full discharge defense to the owner’s performance bond claim.

But it is noteworthy that the surety can also be disadvantaged by the applicable Prompt Payment Act. For example, if a bonded contractor fails to follow the Prompt Payment Act’s requirements to object to a misperforming subcontractor’s payment application and then withholds payment from the subcontractor, the contractor’s violation of the Prompt Payment Act will be treated as a breach of the subcontract. The subcontractor may choose to bring a payment bond claim against the surety, and the surety will not be able to assert default by the subcontractor as a defense to the payment bond claim.

This Article will provide an overview of issues which may arise under the federal and states’ Prompt Payment Acts that affect a surety’s handling of performance and payment bond claims. This is an area which has received little to no attention in surety literature and presentations, yet prompt pay issues often arise in surety cases. This Article will explore possible options and defenses available to the surety when an owner or general contractor has violated the Prompt Payment Act. Also covered in this Article will be what role the Prompt Payment Act may play in situations where a subcontractor is making a payment bond claim against a surety, including whether interest on a prompt payment violation may be recoverable under the payment bond.

II. Explanation of Prompt Payment Acts

States have nearly unanimously followed the federal government’s lead and used the Federal Prompt Payment Act as a template for their public construction.[2] Further, the trend is growing in the states to enact Prompt Payment Acts for non-public or private construction. For example, Massachusetts only recently passed a Prompt Payment Act for private construction projects.[3] However a number of states still do not have Prompt Payment Acts for their private construction projects, including Colorado, Indiana, Iowa, Michigan, Virginia, West Virginia, South Dakota, Oklahoma, Washington and New Hampshire. It is anticipated that the list of states adopting prompt pay statues for private projects will expand in coming years as these states join the growing trend.

Although states have used the Federal Prompt Payment Act as a template, the deadlines in the various Acts differ from state to state. There is no Uniform Prompt Payment Act, and so the states have fashioned their own unique statutory schemes and deadlines. The states’ Acts all follow common themes, as follows:

1. The general contractor is entitled to payment within a certain number of days after the application is submitted (for example, in the author’s home state Arizona, the owner has 14 days to approve and then 7 days to pay a payment application[4]).

2. If the owner disputes all or part of a payment application, the owner must object in writing, quantify the amount disputed, and pay the undisputed amount to the general contractor.[5]

3. The general contractor must pay its first tier subcontractors within a certain number of days of receipt of payment from the owner (for example in Arizona, the time period for the general contractor to pay subs is 7 days[6]). Again, if the general contractor disputes a subcontractor’s payment application, it must object in writing, quantify the amount disputed (which may be the result of withholding by the owner due to the subcontractor’s defective work) and pay the undisputed amount to the subcontractor.[7]

4. If the owner or general contractor does not timely object to a payment application, the application is deemed admitted and failure to timely pay is a breach of contract by the owner or general contractor.[8]

5. In some states, the legislatures have expanded their Prompt Payment Acts to also address change order requests. In these states, such as Nevada, an owner’s failure to timely respond to a contractor’s properly submitted request for change order results in the change order being incorporated into the contract.[9]

6. Typically the Prompt Payment Act provides that its statutory terms are impliedly incorporated into contracts entered into in that jurisdiction, and may not be varied by parties unless permitted by the Act.[10]

To say the least, Prompt Payment Acts as enacted by states can be confusing as written and as applied by the courts. The deadlines set forth in the various states’ Acts differ from state to state, and also differ from the Federal Prompt Payment Act. In some states, an owner is allowed only 5 working days after invoice to make payment[11]; other states allow a longer period up to 60 days to pay the general contractor.[12] Some states have different payment deadlines for public and private projects.[13] Typically, payment deadlines are also different for general contractors and subcontractors, as the time for payment by the general contractor to subcontractors is less than the time for payment by the owner to the general contractor.[14]

A glaring example of a court not understanding a Prompt Payment Act is Stonecreek Bldg. Co., Inc. v. Shure, 216 Ariz. 36, 162 P.3d 675 (App. 2007). In this case, the Court misinterpreted the Arizona Prompt Payment Act and ruled that the statute precluded an owner from withholding payment for defective work performed by the general contractor in a prior pay period (indeed, the owner’s withholding for defective work was held to be a breach of contract). The opinion was heavily criticized by legal commentators and construction organizations. Sureties, in particular, disliked the ruling because it required owners to pay contractors despite knowing that defective work had been performed (albeit at an early time in the construction process). This was clearly not the statutory interpretation intended by the legislature, as reflected by the 2010 legislative amendment to the Prompt Payment Act which essentially overruled the Stonecreek decision.[15]

Bond obligees, particularly unsophisticated bond obligees, often do not understand the nuances of a Prompt Payment Act. Regardless of whether the obligee fails to follow the requirements of a Prompt Payment Act willfully or out of ignorance, the result is the same – a full defense for the surety if the non-payment was for a material amount. In the next section, this Article will explore the scenarios in which prompt pay issues typically arise in surety cases.

III. Scenarios Which May Occur Involving the Prompt Payment Act

There are a myriad of surety situations which may involve a Prompt Payment Act, but in the author’s experience the scenarios fall into one of the following five broad categories:

A. The Bonded Contract Does Not Comply with the Prompt Payment Act

The author has been involved in several large surety matters in which payment provisions of the underlying bonded contract failed to meet requirements of the local Prompt Payment Act. In each case the owner followed the contract’s terms, not the statutory terms of the Prompt Payment Act, when processing payment applications, and the result was the owner was in breach of contract as a matter of law.

In one memorable case with the City of Phoenix involving a wastewater treatment plant project, the City used a contract form published by the Engineers Joint Contract Document Committee (“EJCDC”). The EJCDC is an esteemed organization in the construction industry, as it is a joint venture of four prominent design professionals and contractors organizations (the American Council of Engineering Companies, the American Society of Civil Engineers, the National Society of Professional Engineers and the Associated General Contractors of America). The contract forms issued by the EJCDC are first rate and have been used by municipalities and other public bodies as standard documents since the EJCDC began in 1975. The problem for the City was not the quality of the EJCDC documents, but the fact that the EJCDC contract form did not comply with Arizona’s Prompt Payment Act. From the first draw paid by the City until the contractor was terminated months later, the City had been processing payment applications in accordance with its EJCDC contract form – in other words, processing payment applications in violation of the Prompt Payment Act. The City sued the contractor and its surety upon breach of contract and bond claims exceeding $100 million. The contractor and surety eventually received a summary judgment ruling due to the City’s prompt pay violations; according to the trial court, the City was in breach of contract as a matter of law from the inception of the project. Although the case settled shortly after this ruling from the trial court, and so is not a reported decision, there is no question that the summary judgment ruling was critical to the favorable settlement negotiated by the contractor and the surety.

B. There Is No Dispute with Contractor, but Owner Fails to Timely Pay Contractor

In this scenario the underlying bonded contract has the correct terms, i.e., the contract as written is in compliance with the Prompt Payment Act, but the owner chooses to “slow pay” the general contractor (or the analogous situation where the general contractor chooses to “slow pay” a subcontractor). The easiest contract breach to prove materiality is a payment breach, yet there can still be a question of materiality in an untimely payment situation. Is the late payment material? – the answer is it depends on how much and how late. The Prompt Payment Act provides strict deadlines for payment, and thus improves the chances of proving materiality. Indeed, in certain states’ Prompt Payment Acts, there is even a statutory procedure for the unpaid or late paid contractor to give notice and then terminate if the prompt pay violations are not timely cured.[16]

C. There Is a Dispute with Contractor, So Owner Fails to Pay Contractor and/or Fails to Object to Payment Applications

This is, by far, the most common scenario. In this situation, the general contractor (or, by analogy, the subcontractor) has performed work but the owner is dissatisfied with the quality or timeliness of the work performed. When the contractor submits a progress payment application, the owner chooses to “sit on the application” – neither objecting in writing nor paying the payment application. As stated above, most Prompt Payment Acts require the owner to timely object in writing to a disputed payment application, to quantify the value of the disputed work, and to pay the undisputed amount of the subject payment application. The problem is that tempers flare in disputes, particularly construction disputes, and many owners are not inclined to pay anything to contractors with whom they are fighting – even if they know withholding payment is illegal under the Prompt Payment Act. The failure to timely object to a payment application estops the owner from denying the payment application in most jurisdictions. Further, as discussed above and explained in more detail below, the owner’s obstinate refusal to pay gives the surety a full defense to the owner’s performance bond claim.

Parenthetically, not infrequently an owner will timely object in writing to a payment application yet fails to pay the undisputed amount to the contractor. This is a prompt pay violation, no different than if the owner had failed to timely object and failed to pay. It is the lack of payment which gives rise to the prompt pay violation; regardless of the written objection, the owner has failed to pay money due and owing and so has breached the Prompt Payment Act as well as the contract with the general contractor.

D. Owner Fails to Respond to Change Order Requests

As stated above a few jurisdictions require the owner to timely process, and to object in writing if disputed, a contractor’s properly submitted request for change order. Sometimes an owner in dispute with a contractor will choose not to process change order requests, either in response to perceived provocation by the contractor or simply to hold onto money needed (according to the thinking of the owner) to compensate for defective or untimely performed work. In those jurisdictions, the result is very unfavorable to the owner – the change order request is deemed accepted, and the revised change order amount and/or time for performance are incorporated into the contract for the project. If the change order work has been performed, the contractor is due to be paid in the next payment application for this work.[17]

The beneficial effects for the surety in this scenario are two-fold. First, the owner’s failure to pay gives rise to a surety defense should the owner choose to bring a performance bond claim. Second, in the event of bond losses on that project (either in the surety’s completion of contractor’s work or payment of the contractor’s bills), the surety will be able to recover an increased contract balance from the owner.

E. General Contractor Fails to Pay Subcontractors

Payment bond claims may also be affected by the Prompt Payment Act. In this scenario, the general contractor (bonded by the surety) has been paid by the owner, yet fails to pay a subcontractor and/or fails to object in writing to a subcontractor’s payment application. The problem for the surety is that the general contractor’s prompt pay violation leads to an entitlement by the subcontractor to payment under the surety’s payment bond (although it will be explained below that the surety may have an offset due to the subcontractor’s defective work). Another problem for the surety is that its principal, the general contractor, is estopped from denying a subcontractor’s payment application to which it failed to object (although, again, the surety may have an offset for defective work by the subcontractor). Most of this Article has addressed how the surety is advantaged by prompt pay violations on bonded projects, but unfortunately with regard to payment bond claims the surety can be disadvantaged by its principal’s prompt pay violations.

IV. The Prompt Payment Act’s Impact on Performance Bond Claims

What is the surety’s legal position when the owner/obligee has not complied with the Prompt Payment Act? The surety’s analysis should begin with a review of the text of the performance bond utilized by the contracting parties and the surety. If the project is public construction, the performance and payment bond forms will be mandated by the public works statute. But if the project is private construction, there is a good possibility that the bond form is one of the AIA A312 bonds. Due to the frequency of use of A312 bonds, these bonds will be discussed in some detail below.

Since its release by the AIA over 25 years ago, the A312-1984 Performance Bond has been the surety industry’s preeminent performance bond form. In contrast to the short bond form A311-1970 Performance Bond, the A312-1984 Performance Bond is a long bond form which provides obligees, principals and sureties with a “roadmap” detailing each parties’ rights and obligations under the bond – including specific conditions precedent that must be fulfilled before the surety’s bond obligations are triggered. When the AIA undertook its project to update its bond forms in 2010, the AIA expressly decided not to include a short form performance bond in its revised series. Instead, the AIA opted to continue with its long form A312 bond, and maintained and even expanded the conditions precedent to coverage. Important to this Article, the language conditioning coverage upon absence of default by the obligee was retained in the A312-2010 Performance Bond.

The critical language of the A312 Performance Bond, contained in both 1984 and 2010 forms, is set forth in paragraph 3 as follows: "3. If there is no Owner Default, the Surety’s obligation under this Bond shall arise …"

The term “Owner Default” is defined by the bond to be a “failure by the Owner, which has neither been remedied nor waived, to pay the Contractor as required by the Construction Contract or to perform and complete or comply with the other terms thereof.” As the requirements of the Prompt Payment Act are incorporated as a matter of law into the Construction Contract, there is no question that a statutory prompt pay violation is an Owner Default as defined by the bond. Courts agree that a material Owner Default is a failure of a precondition to the surety’s liability under the A312 Performance Bond. U.S. Fidelity & Guarantee Co. v. Brasparo Oil Service Co., 369 F.3d 34 (2nd Cir. 2004) (paragraph 3 of the A312 Performance Bond contains a number of valid conditions to the surety’s obligations); Enterprise Capitol, Inc. v. San-Gra Corp., 284 F.Supp.2d 166 (D. Mass. 2003) (noted that paragraph 3 creates conditions precedent to the surety’s obligation). Indeed, the obligee has the burden of proving, under the A312 bond form, that it is not in default of its obligations to the bond principal in addition to the other prerequisites to coverage contained in the bond. Travelers Cas. & Surety Co. of America v. Crystal Towers, 2009 WL 5068823 (S.D. Ala. 2009).

Thus, an obligee’s payment default, including a statutory prompt pay default, is a full defense for the surety to a A312 Performance Bond claim. But even if the performance bond form is silent as to the effect of the obligee’s default, the case law establishes the surety’s defense to a bond claim. The reason is that the surety’s liability is co-extensive with its bond principal, and an obligee’s default which excuses contract performance by the principal also excuses bond performance by the surety. American Law Institute, Restatement of the Law of Suretyship and Guaranty, Third, § 19 (1996); Partnership v. Amwest Sur. Ins. Co., 258 A.D.2d 780, 685 NYS 2d 832 (1999) (owner’s failure to make progress payments to the principal discharged the surety for liability under the bond); Sage Street Associates v. Northdale Construction Co., 809 S.W.2d 775 (Tex. App. 1991) (as the jury found that [the owner] did not perform properly per the contact, the court relieved the surety from performance under the bond.), rev’d on other grounds, 937 S.W. 2d 425 (Tex. 1996).

Under the A312 Performance Bond or any other performance bond form, the only issue that should remain following a showing of prompt pay violation by the obligee is materiality of the payment breach. A material breach has been defined by courts as a failure to do something that is so fundamental to the contract that the failure to perform that obligation defeats an essential purpose of the contract. Zulla Steel, Inc. v. A&M Gregos Inc., 174 N.J. Super. 124, 415 A.2d 1183 (N.J. App. 1980) (failure to make payment was material breach); Salo Landscape & Constr. Co., Inc. v. Liberty Elec. Co., 119 R.I. 269, 376 A.2d 1379 (R.I. 1977) (party who fails to make installment payment is guilty of breach that goes to the very essence of the contract). Particularly with regard to progress payments on construction projects, courts are inclined to find a material breach for missed payments. Macri v. United states ex rel. John H. Maxwell & Co., Inc., 535 F.2d 804, 810 (9th Cir. 1965) (“it is well settled that an owner’s failure to make progress payments on a building contract may constitute a material breach”); United States ex rel. C.J.C., Inc. v. Western States Mechanical Contractors, Inc., 834 F.2d 1533 (10th Cir. 1987) (failure to make progress payments when due is a substantial breach of the contract).

There is no doubt in the case law that a material non-payment which discharges the bond principal from its obligation also discharges the surety from its bond obligation to the owner/obligee. McClintock v. Serv-Us Bakers, 5 Ariz. App. 107, 423 P.2d 722 (Ariz. App. 1967) (when the principal is discharged from its obligation, the surety guaranteeing that obligation is likewise discharged), rev'd on other grounds, 436 P.2d 891 (Ariz. 1968); Wellington Power Corp. v. CNA Sur. Corp., 217 W. Va. 33, 614 S.E.2d 680, 687 (W.Va. 2005) (“It is a fundamental precept of suretyship law that the liability of the surety is conditioned on accrual of some obligation on the part of the principal; the surety will not be liable on the surety contract if the principal has not incurred liability on the primary contract”).

In the author’s experience, by far the easiest material breach to prove is a payment breach. Non-payment of a nominal sum, even if a Prompt Payment Act violation, will not be deemed a material default and will not entitle the surety to a performance bond defense. But if the non-payment is for a significant amount of money, the payment breach is likely to be deemed material and the surety should have a full defense to a performance bond claim. The Prompt Payment Act imposes payment obligations on the owner/obligee which are often stricter than contained in the underlying bonded contract, and so expands the “Owner Default” defense which the surety may assert for AIA A312 bonds and even for non-AIA performance bonds.

Notably, there is another way that the performance bond surety may benefit by the owner’s prompt pay violation. Sometimes the surety must bring an action, as subrogee of the general contractor/bond principal, to recover the bonded contract balance from the owner. If the owner has failed to pay according to the Prompt Payment Act, and thus the owner is the breaching party, the owner will not be legally able to assert its own breach claims (for example, for delayed performance by the contractor) against the contractor or the surety. Thus, because the owner is the breaching party, the surety will have a defense to the owner’s performance bond claim and will have an enhanced recovery on an affirmative claim against the owner.

Finally in performance bond cases involving owner prompt pay violations, the surety needs to be mindful of progress or final waivers executed by the contractor in exchange for payments. No reported cases were found involving the Prompt Payment Act and waivers, but the author’s view is that a waiver will be enforceable to release prompt pay violations.[18] If waivers have been given by the contractor, the waivers need to be examined as to scope of release (partial or full), date of release, and whether there are exceptions to the release (for example, an exception for pending claims). In all likelihood, the contractor in a dispute with an owner will not be fully paid by the owner, and thus there will still be valid claims for prompt pay violations notwithstanding waivers for earlier progress payments.

V. The Prompt Payment Act’s Impact on Payment Bond Claims

The prior section described how the surety may be advantaged by application of Prompt Payment Act to a performance bond claim. Bu the converse is also true, i.e., the surety may be disadvantaged by application of a Prompt Payment Act to a payment bond claim. This situation arises when a bonded general contractor is in dispute or otherwise fails to pay a subcontractor, leading the subcontractor to submit a payment bond claim to the general contractor’s surety.

Typically, a state’s Prompt Payment Act requires written objection by the paying party (in this hypothetical situation, the general contractor) to a payment application within a certain time period, otherwise the payment application must be fully paid by the general contractor.[19] The general contractor’s failure to pay will cause it to be the breaching party, thus entitling the subcontractor to various rights under the Prompt Payment Act as well as common law contract remedies.[20] Assuming that the subcontractor has met all bond notice and limitations requirements, the subcontractor should be able to recover on the payment bond issued by the surety (as the surety’s liability is co-extensive with its bond principal/general contractor).

What if the subcontractor had performed defective or untimely work? In the absence of the Prompt Payment Act, the general contractor and the surety could argue that the subcontractor is the breaching party and so is unable to enforce contract or bond rights. This argument is lost due to the general contractor’s prompt pay violation (thus the surety is disadvantaged), but the general contractor and the surety may still claim setoff to reduce the subcontractor’s claim. With regard to the Federal Prompt Payment Act, the federal courts have established that affirmative claims and setoffs are available to a party who has failed to comply with the Prompt Payment Act. Weitz Co. v. MH Washington, 631 F.3d 510 (8th Cir. 2011) (jury was allowed to setoff amounts owed to the claimant even though prime contractor had violated the Prompt Payment Act); Nwogu v. U.S., 94 Fed. Cl. 637 (Fed. Cl. 2010) (court approved setoff by U.S. Navy which decreased claimants’ recovery under the Prompt Payment Act). In both cases, the courts recognized a party’s right to utilize setoff to reduce a claimant’s damages, even in circumstances where the Prompt Payment Act has been violated.

Although not as fully developed in state Prompt Payment Act cases, the reported state court decisions which have addressed this issue support setoff for affirmative claims despite a prompt pay violation. For example, in Jerry Bennett Masonry, Inc. v. Crossland Construction Co., Inc., 171 S.W. 3d 81 (Mo. App. 2005), a masonry subcontractor brought an action against the general contractor and its payment bond surety for failure to timely pay the final payment application in violation of the Missouri Prompt Payment Act. The general contractor argued that it was entitled to decrease the final payment by damages it incurred due to the delayed work of masonry subcontractor. The trial court and appellate court agreed with the general contractor. Although a Prompt Payment Act violation had occurred in the general contractor’s withholding of final payment, this violation did not preclude the general contractor from asserting a legitimate setoff. The setoff was also available to the surety on the masonry subcontractor’s payment bond claim.

Courts in Illinois and California have arrived at similar conclusions allowing setoffs to Prompt Payment Act claims, which served to decrease the total amount due to the claimant despite prompt pay violations. Superior Structures Company v. City of Sesser, 292 Ill.App.3d 848, 686 N.E.2d 710 (Ill. App. 1997) (although opinion concentrated on issues concerning interest when a violation of the prompt payment act occurred, the setoff which decreased the amount due to claimant was approved by the appellate court); Kalfountzos v. Hartford Fire Ins. Co., 44 Cal. Rptr. 2d 714 (Ct. App. 1995) rev’d on other grounds, Wm. R. Clarke Corp. v. Safeco Ins. Co., 938 P.2d 372 (Cal 1997) (allowed surety to use setoff to decrease amount due to subcontractor, who had claim against general contractor for unpaid progress payments).

Another question which may arise is whether the surety is liable for Prompt Payment Act interest on a payment bond claim. Typically Prompt Payment Acts will provide for a high interest rate to be paid by a party who commits a prompt pay violation. The overwhelming majority view is that this statutory interest obligation constitutes a “penalty” which is not covered by the surety’s payment bond. R.W. Sidley, Inc. v. U.S. Fidelity & Guarantee Co., 319 F. Supp.2d 554 (W.D. Pa. 2004) (classified Pennsylvania’s prompt payment interest provision as “penalty interest” which is not recoverable under a payment bond); Intercargo Ins. Co. v. Municipal Pipe Contractors, Inc., 1127 Ohio Misc. 2d 48, 805 N.E. 2d 606 (Ohio 2003) (finding Ohio’s prompt payment statutory interest constituted a penalty); City of Independence for Use of Briggs v. Kerr Const. Paving Co., Inc., 957 S.W.2d 315 (Mo.App. 1997) (surety was not liable for penalties incurred because of violation of prompt payment statute, but surety was liable for non-penalty interest); New Design Construction Co., Inc. v. Harmon Contractors, Inc., 215 P.3d 1172 (Col. App. 2008) (surety liable for interest in contract but not penalty interest in statute).

There is one wayward (and, in the author’s opinion, wrongly decided) case found in this area. Washington International Ins. Co. v. Superior Court, 62 Cal.App.4th 981, 73 Cal. Rptr.2d 282 (1998) (allowed statutory penalties incurred by the principal due to prompt pay violation to be part of judgment against surety). Thus, if the overwhelming majority view is followed, this is one circumstance in which the surety’s liability is not co-extensive with its bond principal’s liability, as the surety is not liable for the Prompt Payment Act interest arising from the general contractor/bond principal’s prompt pay violations.

VI. Conclusion

Although the Federal Prompt Payment Act became law nearly 30 years ago, the states’ Prompt Payment Acts are much more recent in many jurisdictions. Many in the construction industry either do not know these laws or choose to ignore these laws. What is not generally known in the construction industry are the severe consequences which will result from a willful or even unintended violation of the Prompt Payment Act.

Failure to timely and fully pay progress payments to a contractor on an ongoing construction project is not a technical default – it is a real problem for contractors who must pay their own project bills – and so it is a default which is easily understood by jurors, judges and arbitrators. The huge potential benefit for the surety of the Prompt Payment Act is that it expands an owner’s payment default as a matter of law. Summary judgment for the surety on a performance bond claim is a real possibility in a case involving an owner’s prompt pay violation. As a practical matter, even without a summary judgment ruling, proving an owner’s failure to pay according to the applicable Prompt Payment Act will greatly help the surety in defense of bond claims and in affirmative recoveries.  u