What is a Surety?
Surety is a form of financial credit known as a bond guarantee. The transaction always involves three parties; the obligee, the principal and the surety. A surety bond protects the obligee (the party to whom the bond is paid to in the event of a default) against losses, up to the limit of the bond, that result from the principal’s (the party with the guaranteed obligation) failure to perform its obligation. The surety, for example an insurance company, assumes the obligation if the principal cannot.
What is a Surety Bond?
Surety bonds are designed to ensure that principals act in accordance with certain laws. They provide the obligee with financial guarantees that contracts and other business deals will be completed in accordance with mutual terms. If the principal breaks those terms, the harmed obligee can make a claim on the surety bond to recover losses incurred. The surety company then has the right to be reimbursed by the principal in the case of a paid loss or claim.
Common types of Surety Bonds
Two of the most common forms of surety bonds are contract surety and commercial surety. A helpful explanation by the Surety Association of Canada describes the two as the following:
Contract Surety - Contract Surety Bonds provide financial security and construction assurance on building and construction projects by assuring the project owner (obligee) that the contractor (principal) will perform the work and pay certain subcontractors, laborers, and material suppliers. The obligee is protected against a contractor’s inability to complete a job.
Three Basic Types of Contract Surety Bonds
Other Types Surety of Bonds
1. The Bid Bond assures that the bid is submitted in good faith and that the contractor will enter into the contract at the price bid and provide the required performance and payment bonds.
2. The Performance Bond assures the owner that, in the surety’s opinion, the contractor is capable and qualified to perform the contract and protects the owner from financial loss should the contractor fail to meet the terms and conditions of the contract. A qualified, bonded contractor is more likely to complete the project according to the contract provisions. Default is not in the best interest of the surety, contractor, or owner. When problems occur, the surety may offer financial, technical, or managerial assistance to the contractor in order to prevent default.
3. The Payment Bond assures that the contractor will pay specified subcontractors, laborers and materials suppliers associated with the project.
Commercial Surety - Commercial Surety Bonds guarantee performance by the principal of the obligation or undertaking described in the bond.
License and Permit Bonds: Required by federal, state, or local governments as a condition for obtaining a license or permit to engage in a specified activity, this bond guarantees that the party seeking the license or permit (obligor) will comply with applicable laws or regulations.
Court Bonds (also called judicial bonds): Required of a plaintiff or defendant in judicial proceedings to reserve the rights of the opposing litigant or other interested parties. Court bonds include appeal bonds, probate bonds, attachment bonds, and injunction bonds.
Fiduciary Bond (also called probate bonds): Required of those who administer a trust under court supervision. Typical such bonds are executor and administrator bonds, trustee bonds, guardian bonds, and conservator bonds.
Public Official Bonds: Required by statute for certain holders of public office, to protect the public from malfeasance by an official or from an official’s failure to faithfully perform duties. Public official bonds included county clerk bonds, tax collector bonds, notary bonds, and treasurer bonds.
Miscellaneous Bonds: are generally described as any private or public bond not readily classified under the other bond types. These bonds are vast in their scope and are often broad coverages whose risk factors and obligations are only defined and ascertained within the underlying obligation being bonded. Quite often, the real obligation being bonded is the compliance to the underlying agreement and in the event of failure to comply, the payment of money to compensate for recouping of losses, or as a penalty for default.
What is required of a principal before a Surety will be granted?
Before principals can obtain a contract bond, he or she undergoes an extensive prequalification process called underwriting to enable the surety to capture a clear picture of the company.
A surety company must be satisfied that the contractor runs a well-managed, profitable business, keeps promises, deals fairly, and performs obligations in a timely manner.
Underwriters use financial statements and business plans, among other factors, to help determine a contractor’s surety capacity. Other criteria include:
· Good references and reputation;
· The ability to meet current and future obligations;
· Experience that matches the contract requirements;
· The necessary equipment and personnel to do the work or the ability to obtain it;
· The financial strength to support the desired work program.
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