SURETY 101

What is a Surety Bond?

Three Party Agreement

A bond is issued by an entity known as the "Surety" on behalf of a second party, the "Principal," guaranteeing that the Principal will fulfill an obligation or series of obligations to a third party, the "Obligee." If the Principal fails to meet these obligations, the Obligee can recover its losses through the bond.

Not Insurance

Although Surety bonds are typically issued by insurance companies, they are not a form of insurance. Instead, they represent a financial assurance provided by the Surety to the Obligee (often a government entity), ensuring that monetary damages will be paid if the Principal defaults, fails to uphold its promises, or becomes insolvent.

Typically Required By Governments

Surety bonds are required for various government jobs, construction projects, and court mandates. Additionally, certain industries must obtain bonds from federal, state, or local governments before a business license is issued to protect citizens.

Guaranteed By Insurers

The Principal pays a premium in exchange for the Surety's commitment to guarantee the bond(s) to the Obligee. If the Principal defaults and the Surety is insolvent, the bond becomes worthless. This is why insurance companies, whose financial strength and solvency are verified by private audits and/or governmental regulation, are typically authorized to underwrite Surety bonds.

Insurer Losses Are Recoverable

In the event of a claim, the Surety will investigate, pay, and usually seek reimbursement from the Principal for the claim amount paid plus any legal fees incurred. In some cases, when the Principal is unable to fulfill its obligations, the Surety may choose to "Subrogate," which involves substituting for the Principal to fulfill the terms of the obligation and/or recovering damages.

Terms & Definitions

sur•e•ty (/SHoorite/) - Noun

1. An entity who takes responsibility for another's performance of an undertaking; Commonly referred to as a "The Surety".

2. Money given to support an undertaking that someone will perform a duty, pay their debts, etc.; a guarantee

bond (/band/) - 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 (/prinsepel/) - Noun

The primary party will be performing the contractual obligation. If a surety bond were to be compared to an insurance policy, the principal would be referred to as the Insured party.

ob•li•gee (/ablije/) - Noun

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

Types of Surety Bonds

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.

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.

Fidelity Bonds

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.

Bail 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.

Developer Surety

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 Surety Bonds Are 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.

How Surety Bonds Are Priced

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”).