What is a Surety Bond?
A surety bond guarantees performance. A surety bond is a contractual promise by a surety (or guarantor) to pay an obligee a set amount of money if a principal fails to meet some obligation or fails to perform as promised. The obligation can range from fulfilling the terms of a contract to appearing in court after posting bail. A surety bond guarantees the principal's performance and protects the obligee against financial losses that result from the principal's failure to meet the obligation.
How is a Surety Bond different from Insurance?
There are three important distinctions between surety bonds and most insurance policies:
1) A surety bond is a contract among at least three parties:
- the obligee: the party who is the recipient of a contractual obligation.
- the principal: the party who will perform the obligation.
- the surety: the party who issues the bond and guarantees the obligee that the principal will perform the task.
If the principal fails to perform the task as required by the contract, then the surety (usually an insurance company) that issued the bond pays the obligee the amount of the bond. The principal also purchases the surety bond, often as a condition for getting the contract.
An Insurance Policy is a contract between two parties:
- the insurance company who issues the policy.
- the principal who both purchases the policy and is the recipient of any funds the policy may pay out on a claim.
2) The surety's duty is to the obligee, not to the principal, even when the principal purchases the bond. If the principal is dishonest and makes false statements on an insurance application, the insurance company will generally be relieved from paying on a claim.
Not so on a surety bond, wherein the surety (usually an insurance company) is still obligated to the obligee for payment on the bond despite any dishonest actions by the principal.
3) If the principal fails to perform the task and the surety (the insurance company) must pay the obligee the amount of the bond, then the insurance company has the right to sue the principal for the amount of the bond. For this reason, the surety will not issue a bond greater than the value of the liquid assets of the principal.
What are the Types of Surety Bonds?
There are many different types of surety bonds. Commercial Surety Bonds are used by businesses. The most common commercial surety bonds are contract bonds, performance bonds and fidelity bonds which are available through Alliance Insurance Agency Services, Inc.
Another type of bond common in the construction industry are License and Permit Bonds. License and Permit Bonds are often required for contractors licensed to work within a state or town. These bonds guarantee that the principal (the contractor) will comply with any required permits and building codes.
Not all surety bonds are designed for use in business. Below are some examples of non-commercial surety bonds
Public Official Bond - Usually required by state law for elected or appointed public officials who have access to public funds. A public official bonds guarantees that the public official will not embezzle the funds.
Judicial Bond - Judicial bonds are usually required by the court for litigants or people appointed to perform certain duties. There are several types of judicial bonds.
Fiduciary Bond - A fiduciary bond is generally required by fiduciaries who will handle the money or property of another, such as the administrators of estates or the guardians of minors.
Court Bond - A court bond protects a defendant whose property has been attached by a plaintiff because of previous legal proceedings, against the loss of the attached property or money should the plaintiff lose in a subsequent proceeding.
Bail Bond - A bail bond, bought by the defendant, pays the court if the defendant fails to appear for court.
What are Contract Bonds?
Contract bonds guarantee that the principal will satisfactorily perform everything that is required on a contract. Although contract bonds can be issued in a wide range of industries from manufacturing to entertainment, they are most common in the construction industry. In the construction industry, contract bonds are often referred to as construction bonds.
Different types of contract bonds guarantee different phases of a contract.
Bid bonds guarantee that the winning bidder will actually sign a contract and purchase payment and performance bonds.
Performance bonds, common in the construction industry, guarantee that a contractor (the principal) will complete the project according to the contract.
Payment bonds guarantee that all workers, subcontractors and suppliers are paid so that unpaid workers and suppliers do not sue the obligee or place a lien on the obligee's property where work was performed.
Maintenance bonds guarantee the workmanship of the contractor (the principal). Most performance bonds include a 1-year maintenance bond.
Ancillary bonds guarantee that other provisions of a contract not related to performance are also completed satisfactorily.
What is a Performance Bond?
A performance bond is a type of contract bond very common in the construction industry. A performance bond guarantees that the principal (the contractor) will satisfactorily complete a project according to the contract. A performance bond is is issued by an insurance company or a bank.
(Outside the construction industry, non-construction performance surety bonds are used to help ensure fulfillment of virtually any contract obligation such as performance bonds issued when stock futures are bought on a margin, a type of down payment).
If a construction project is not completed according to the contract, the surety (insurance company or bank) will either hire and pay for another contractor to finish the work or compensate the obligee for any monetary loss up to the amount of the performance bond. The principal (the contractor) is then indebted to the surety for the amount of the bond and the surety can sue the principal to recover the amount of the bond.
Performance bonds are generally issued as part of a 'Performance and Payment Bond' by the surety. The payment bond guarantees that all workers, subcontractors and suppliers will be paid by the contractor. This avoids suits and liens by unpaid workers and suppliers.
Performance bonds are often accompanied by a bid bond issued by the same surety. The bid bond guarantees that the winning bidder of the construction project will actually sign a contract and purchase payment and performance bonds. Performance bonds usually cover 100 percent of the contract price and replace the bid bonds on award of the contract.
What is a Fidelity Bond?
A fidelity bond is purchased by employers to protect them against theft and fraud by an employee or from damage from mismanagement by an employee. A fidelity bond (also called fidelity insurance, crime insurance or employee dishonesty insurance) works like supplemental insurance for a business since most commercial insurance policies do not cover employee theft or employee fraud.
A fidelity bond helps a business recover losses due to employee dishonesty such as: employee theft, misappropriation of company funds, employee theft on client premises or while performing services for others, forgery, deliberate destruction, robbery, safe burglary and computer and funds transfer fraud. Fidelity bonds are typically created to manage long-term relationships and not individual projects.
Fidelity bonds are like other surety bonds, in that 3 parties are involved, except that the contractual obligations exist only between the principal (the employer) and the surety (the insurance company). The insurance company pays the employer for losses caused by its covered employees to the limit of the bond. Like other surety bonds, the surety (the insurance company) can sue the for recovery of monies paid. However, unlike other surety bonds, the surety sues the dishonest employee and not the principal (the employer).
One of the largest industry wide users of fidelity bonds are banks and other financial institutions. With so many employees handling money and other valuable assets, the fidelity bonds used by these businesses are known as financial institution bonds.
There are two common types of fidelity bonds, blanket bonds and schedule bonds. A blanket fidelity bond covers any employee working for the employer. A scheduled fidelity bond covers only specifically named people or positions in the company.
Can Anyone Get a Bond?
Surety bonds are issued to principles (businesses and individuals) who are deemed a good risk.
Small contractors such as electricians, plumbers, roofers, carpenters, painters and landscapers can usually acquire performance and payment bonds with good credit, sufficient assets and good customer references. The larger the bond, the more additional vetting is required to assure that the principal is a good risk for the amount of the bond.
Because the company that issues a surety bond will sue the principal, if it is obligated to pay the obligee of the surety bond, a major consideration will be the financial assets, debts, and working capital of the principal. Other considerations would be bank lines of credit, whether the principle pays their bills promptly and has good customer references. In the case of a construction project, the surety company will evaluate the contractor to be sure he has the resources and capacity to perform the contract according to its terms and conditions.
Contact a Commercial Insurance Specialist from Alliance Insurance Agency Services, Inc. for a free evaluation of the bonding status of your business or construction project. Alliance Insurance offers contract bonds, performance bonds, fidelity bonds and more to qualified businesses.