Surety 101

What is a Surety Bond?

A bond is issued by an entity “the Surety” on behalf of a second party “the Principal”, guaranteeing that the second party will fulfill an obligation or series of obligations to a third party “the Obligee”. In the event that the obligations are not met, the third party will recover its losses via the bond.

While Surety bonds are typically issued by an insurance company, they are not insurance. It is financial assurance given by a Surety to an Obligee (typically a government entity) ensuring that money damages will be paid in the event that the Principal either defaults, fails to uphold its promises, or becomes insolvent.

Surety bonds are required for many government jobs, construction jobs or by the court. Additionally, certain industries are also required by federal, state, or local governments to have bonds before a business license will be issued in order to protect its citizens.

The principal pays a premium in exchange for the surety’s commitment to guarantee a bond(s) to an Obligee. If the principal defaults and the surety turns out to be insolvent, the bond worthless. Which is the reason why insurance companies, whose financial strength and solvency is verified by private audit and/or governmental regulation, are typically granted licensing and authority to underwrite Surety Bonds.

In the event of a claim, the surety will investigate, pay, and typically seek reimbursement from the principal for the claim amount paid plus legal fees incurred. In some circumstances, when the principal is unable to fulfill its obligations, the surety has choose to “Subrogate” which includes substituting for the principal in order to fulfill the terms of an obligation and/or recovering damages.

Definitions

sur·e·ty
/ˈSHooritē/

Noun

  1. An entity who takes responsibility for another’s performance of an undertaking; Commonly referred to as “The Surety”
  2. Money given to support an undertaking that someone will perform a duty, pay their debts, etc.; a guarantee

bond
/bänd/

Noun

  1. an agreement with legal force, in particular.
  2. Proof/Documentation of money given to support an undertaking that someone will perform a duty, pay their debts, etc.; a guarantee

prin·ci·pal
/prinsəpəl/

Noun

  1. The primary party who will be performing the contractual obligation

ob·li·gee
/äbliˈjē/

Noun

  1. A third party of a surety bond to whom the surety bond principal is guaranteeing they will fulfill their obligations and for whose protection the bond is written

sub·ro·ga·tion
/səbrəˈɡāSHən/

Noun

  1. The substitution of one person or group by another in respect of a debt or insurance claim, accompanied by the transfer of any associated rights and duties.
  2. An equitable remedy to fulfill the obligee’s claims against the principal who is responsible for the loss.

What Types of Surety Bonds Are Available?

  1. Contract Surety: Utilized heavily in the construction industry by general contractors as a part of construction law, a guarantee from a Surety to a project owner (the Obligee) that a contractor (the Principal) will adhere to the provisions of a contract.
    • Bid Bond: Guarantees that the bidder will carry out the contact at the bid price if bid is awarded; Provides protection especially in circumstances when the Obligee has accepted the lowest cost bid that the project will be completed even if the contractor has under bid.
    • Performance Bond: Guarantees that a Principal has the financial resources to complete the job from start to finish. If the contractor fails to complete the project in accordance with the terms of the agreement, the surety company will either complete the contract itself, or arrange for a contractor approved by the Obligee to complete the contract.
    • Payment Bond: Guarantees that Principal will pay the subcontractors and material suppliers involved the project.
    • Maintenance Bond: Guarantees for a specified time period against defects and faults in materials, workmanship, and design that could arise later if the project was finished incorrectly.
  2. Commercial Surety: Provides permission to perform work under the conditions that the Principal will conduct business in accordance with the local, state and federal laws. Commercial bonds typically cost less than Contract bonds and are easier to obtain because of their decreased risk.
    • License & Permit Bonds: Guarantees to a government and its constituents (the Obligee) that a Principal will comply with an underlying statute, state laws, ordinances, and regulations. Examples include the following: Motor Vehicle Dealer Bonds and Real Estate Broker’s Bonds.
    • Court Bonds: Guarantees to a government that the Principals whom courts have entrusted with the care of property or welfare of another person will faithfully perform their specified fiduciary duties as ordered by the court. Examples include Appeals Bonds, Replevin Bonds, and Bail Bonds.
    • Public Official Bonds: Guarantees the honesty and faithful performance of Principals who are elected or appointed to positions of public office. Examples of officials who may require bonds include: notaries, treasurers, judges, and law enforcement officers.
    • Miscellaneous Bonds: Bonds that cannot be categorized within the afore mentioned categories covering Obligees with unique needs. Examples include Hazardous Waste Removal Bonds and Guarantee Bonds.
  3. Fidelity: also known as employee dishonesty bond, covers theft of an employer’s property by its own employees. Though referred to as bonds, fidelity is a two party contract more resembling a traditional insurance policy rather than a surety bond.
  4. Developer: exclusively used by developers mainly for residential projects but also for commercial projects.
    • Subdivision: guarantees that a residential developer will perform its obligations to the municipality under the subdivision agreement
    • Warranty Bonds: can be called on in the event the developer fails to abide by the warranty provisions required by jurisdictional laws
    • Purchaser’s Deposit: allows a purchaser to defer the payment of some of these deposits until the purchaser occupies the condominium unit.
    • Condominium Deposit Insurance (CDI): guarantees that the deposits will be repaid to the purchaser if the developer fails to deliver the purchaser’s condominium in accordance with the purchase agreement.
    • Excess Condominium Deposit Insurance (ECDI): guarantees the return of the purchasers’ deposits paid in excess of the amounts required by law

How Is A Bond Purchased?

A bond is typically purchased via local insurance agents who represent the surety. However, many insurance companies have begun to issue Surety Bonds directly to Principals in an effort to reduce risk and commissions paid to agents. Bond costs vary dependent on bond type, the Principal’s credit history, financial performance, and many other factors that are taken into consideration by underwriters. In addition, fees may be assessed by the Obligee and/or the Surety. But typically, the cost (referred to as “the Premium”) is usually between 1 and 4 percent of the total bond amount needed (also known as “the Penalty” or “the Penal Sum”).

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