1. What is a surety bond?
  2. What are the different types of bonds?
  3. What are Miscellaneous and Commercial Bonds?
  4. What is a Fidelity Bond?
  5. Why do I need a court bond?
  6. Why Bond Sub-Contractors?
  7. What are the differences between surety bonds, insurance and irrevocable letters of credit?

What is a surety bond?

The actual definition of a surety, from Webster, is “the state of being sure; assurance; a formal engagement given for the fulfillment of an undertaking; one who has become legally liable for the debt, default, or failure in the duty of another.” Simply put, a surety bond is a promise to be responsible for the debt, default, or failure of another. In most instances, bonds are required by federal, state, and local governments to protect the taxpayer dollars that are paying for the project. There are three parties involved in a surety bond:

Obligee – the entity or individual to which the bond is given.

Surety – the financial institution writing the bond; becomes the bearer of the risk.

Principal – the party that requires the bond and on whose behalf the bond is written.

In a simple example of a construction project, the project owner would be the obligee, the insurance company would be the surety, and the general contractor would be the principal. If the principal cannot complete the project and fulfill both the project obligations and financial obligations to the sub-contractors, material suppliers, etc, the surety must step in and see that the project is completed, and that all bills are paid. Surety bonds can also act as an element of prequalification. By being bonded, a company is saying that they have undergone the examination by a surety and have been qualified to do the project. This underwriting process, which leads to a surety bond approval, is designed to prevent any loss on the part of the obligee, with the surety’s prequalification process asserting the financial strength of the principal as well as their expertise. The surety bond company is putting its assets and financial strength behind the contractor. Because of the rigorous prequalification, there is little expectation of loss in the surety bond relationship.

What are the different types of bonds?

Bid Bonds – The bid bond is a very basic instrument in the prequalification process. The obligee knows that the principal has been thoroughly underwritten by the surety and the surety feels that the principal can complete the project. A bid bond is the bid security that the principal will enter into the contract if awarded the project, and will provide the performance and payment bonds required for the project.

Performance Bonds – The performance bond guarantees that the principal will perform the duties set forth in the contract and that the principal will complete the project in accordance with the contract plans and specifications while performing all the associated obligations under the contract. The main purpose of the performance bond is to protect the obligee from a failure on the part of the principal.

Labor & Material Payment Bonds – The payment bond protects sub-contractors and suppliers of labor and material.

Closure and Post-Closure Bonds – These bonds are used to guarantee that a landfill will be closed in accordance with the obligee’s specifications after the landfill is closed and that it will be monitored in the future.

Reclamation Bond – These bonds guarantee compliance in the mining of coal and other minerals, guaranteeing the land will be reclaimed in accordance with state regulations.

Subdivision Bond – This bond is required by municipalities generally from the developers of real estate guaranteeing any improvements the developer installs such as streets, sidewalks, storm and sanitary sewers will be installed in accordance with regulations and in some instances the bond also guarantees those contractors working for the developer will be paid.

What are Miscellaneous and Commercial Bonds?

License and Permit Bonds – These bonds guarantee that the principal will follow the terms of the license for which they filed. They protect the citizens of a city, county or state from damages stemming from the actions of the principal, and require the principal to comply with all laws. They are a prerequisite to the granting of the license or permit.

Mortgage Broker Bonds – Mortgage broker bonds ensure that the mortgage broker will conduct business in accordance with the rules and regulations of his/her states licensure code. They are required by state governments and each state has different requirements of their mortgage brokers.

What is a Fidelity Bond?

A fidelity bond is a bond that protects a business from financial loss sustained by dishonest acts committed by its employees. Specifically, it protects an employer against theft, larceny, or embezzlement by an employee. Blanket fidelity bonds cover groups of employees.

Why do I need a court bond?

Debilitating health due to sickness or age can lead to impaired judgment and the inability to handle complex tasks such as paying bills, taxes and keeping and remembering important dates.

When a family member or friend needs to step in and handle the day-to-day financial affairs, they need the authority of the State Court to designate them as a Guardian, Personal Representative, Conservator or Trustee of the estate.

An Attorney is generally needed to draw up a petition outlining the need for a conservatorship on behalf of their client; the Petitioner. The Judge looks at the present financial condition of the estate, the circumstances of the petition and if all the paperwork is in order and the petition sound, makes a ruling to appoint the Petitioner. At the time of the appointment the Judge directs the Petitioner to provide a surety bond.

The Petitioner may ask, “Why do I need a surety bond?” The bond is a three party agreement between the Estate of the incapacitated party, the Surety and the Petitioner. The Court requires the Petitioner to make an annual accounting of how they manage the Estate. Without this agreement, the Petitioner has zero accountability to the Estate and no incentive to safeguard the estate and its assets.

Why Bond Sub-Contractors?

Bonds are not always required of sub-contractors on a project. The sub-contractors bond will protect the general contractor against default of the sub-contractors performance obligation and also protects the general contractor against non-payment of suppliers or others working for the sub-contractor. Often times the surety for the general contractor will require he bond his subcontractors to reduce or limit his exposure.

What are the differences between surety bonds, insurance and irrevocable letters of credit?

The biggest difference between a surety bond and insurance policy is that insurance is a two party risk transfer mechanism and a surety bond is a three party agreement. Insurance creates a pool funded by premiums from a large group of people or companies that are exposed to similar risk. Each individual or company contributes premium and any member of the group that suffers a loss has access to the funds in the pool. Insurance companies expect to experience losses. Surety companies on the other hand do not expect to experience any loss. The premium paid to a surety company is to cover the cost of the prequalification or underwriting process. In the event there is a loss, surety companies expect to be reimbursed for their loss. An irrevocable letter of credit is a guarantee issued by a bank to another party covering non-performance or non-payment of an obligation by a contractor. The bank performs no prequalification service for the beneficiary and is primarily concerned the contractor can pay back any funds that may be advanced under the irrevocable letter of credit. Sureties provide a much greater service to an obligee by virtue of the prequalification process and a bond also provides a measure of protection to the contractor against unjust claims.