5.2 Bonds, Public Works Bonding & the Building Contract Fund Act
Key Takeaways
A surety bond has three parties: the principal (contractor), the obligee (owner or government), and the surety that guarantees the principal's obligation.
A performance bond guarantees the work will be completed, and a payment bond guarantees that subcontractors, suppliers, and laborers will be paid.
Michigan's Public Works Bond Act requires a performance bond and a payment bond before a public construction contract over $50,000 is awarded.
Under the Building Contract Fund Act, payments to a contractor for a project are a trust fund for those who supply labor and materials to it.
Using those funds with intent to defraud before paying the project's laborers, subcontractors, and suppliers is a felony, punishable by a fine of $100 to $5,000 and 6 months to 3 years in prison.
How a Surety Bond Works
| Party | Role |
|---|---|
| Principal | The contractor that promises to perform |
| Obligee | The party protected: owner, government, or licensing agency |
| Surety | The bonding company that guarantees the principal's performance to the obligee |
Bonds differ from insurance in a key way. If the surety pays a claim, the contractor must reimburse the surety under the indemnity agreement the contractor (and often its owners personally) signed. The surety underwrites the contractor's character, capacity, and capital: its history, ability to perform, and finances, especially working capital (Section 4.2).
Types of Bonds
| Bond | Guarantees | Typical use |
|---|---|---|
| Bid bond | The bidder will sign the contract and provide performance and payment bonds if awarded, or pay the obligee's loss | Public and commercial bids |
| Performance bond | The work will be completed according to the contract | Public and larger private jobs |
| Payment (labor and material) bond | Subcontractors, suppliers, and laborers will be paid | Public jobs, where liens are unavailable |
| License or permit bond | Compliance with licensing or permit laws | Required by some municipalities or programs |
| Maintenance (warranty) bond | Defects discovered within a set period after completion will be corrected | Some public and commercial roofs |
Michigan's builder and M&A license does not require a surety bond. The rules still contain a provision (R 338.1526(1)) suspending any license predicated on a bond if the bond is cancelled and not replaced.
Michigan Public Works Bond Act (1963 PA 213)
Before a contract exceeding $50,000 for construction, alteration, or repair of a public building or public work of the state, a county, city, village, township, school district, public educational institution, or other public agency is awarded, the principal contractor must provide a performance bond and a payment bond at its own cost (MCL 129.201). The governmental unit may not require the bonds to come from a particular surety, agent, or locality. Because construction liens cannot attach to public property, the payment bond is how subcontractors and suppliers on public jobs protect themselves.
The Building Contract Fund Act (1931 PA 259)
This short statute appears on PSI's reference list and in LARA's continuing competency topics. It is one of the most serious rules in construction money handling.
- Trust fund. In the building construction industry, the building contract fund paid by any person to a contractor, or by a contractor to a subcontractor, is a trust fund for the benefit of the person making the payment and for contractors, laborers, subcontractors, and material suppliers. The contractor or subcontractor is the trustee (MCL 570.151).
- Crime. A contractor or subcontractor who, with intent to defraud, keeps or uses any of those payments for any purpose other than first paying the laborers, subcontractors, and material suppliers engaged for that specific improvement is guilty of a felony. The penalty is a fine of $100 to $5,000 and/or 6 months to 3 years in state prison (MCL 570.152).
- Evidence of intent. Appropriating the money before paying all amounts due or becoming due to laborers, subcontractors, and suppliers is evidence of intent to defraud (MCL 570.153).
How It Connects to Licensing and Liens
- Diversion of funds received for a specific project to another project or purpose is also a disciplinary ground (MCL 339.2411(2)(b)). So is failing to account for or remit money belonging to others (MCL 339.2411(2)(c)).
- If suppliers go unpaid, they may record construction liens against the owner's property (Sections 5.3 and 5.4). The owner may then have paid twice, which is exactly what sworn statements and waivers are meant to prevent.
A Practical Example
A roofer takes a $9,000 deposit on the Smith job, buys $6,500 of materials on credit, and uses the deposit to finish the Jones job. The supplier's invoice then goes unpaid. The roofer has diverted Smith trust funds. Smith faces a supplier lien. The roofer faces discipline under MCL 339.2411(2)(b) and possible felony charges under the Building Contract Fund Act. Deposit tracking by job, paying each job's suppliers from that job's funds, and giving the owner sworn statements and waivers prevent this outcome.
Bonds vs. Insurance vs. Liens
| Tool | Who it protects | Who ultimately pays the loss |
|---|---|---|
| Liability insurance | The contractor, against third-party claims | The insurer, subject to deductible and limits |
| Surety bond | The obligee (owner, government, suppliers) | The contractor, through indemnity to the surety |
| Construction lien | Unpaid contractors, subcontractors, suppliers, and laborers on private property | The owner's property secures the debt |
| Building Contract Fund Act | Everyone who supplies labor or materials, plus the payer | A criminal remedy against the contractor |
Exam Traps
- A surety bond is not insurance for the contractor. The contractor repays the surety.
- The public bond threshold in Michigan is contracts over $50,000.
- The Building Contract Fund Act requires intent to defraud, but using the money before paying the job's suppliers is evidence of that intent.
In a performance bond for a school reroof, which party is the obligee?
The roofing contractor
The school district that awarded the contract
The bonding company
The shingle manufacturer
Under the Michigan Public Works Bond Act, what must a principal contractor furnish before a $120,000 public school roofing contract is awarded?
Only a bid bond
Only proof of liability insurance
A performance bond and a payment bond
A maintenance bond for 10 years
A roofer uses a customer's project payment to cover another job's payroll while that customer's shingle supplier remains unpaid. What does the Building Contract Fund Act say about this?
It is allowed if the roofer eventually pays the supplier
It applies only to public contracts
Using the funds before paying the project's laborers, subcontractors, and suppliers is evidence of intent to defraud, and a violation is a felony
It creates only a civil debt with no criminal penalty
Sections you finish are checked off in the contents.