Frequently Asked Questions
Common Terms Associated With Bonding
Bid Bond: An obligation undertaken by the bidder promising that the bidder will, if awarded the contract, enter into the contract and furnish the prescribed payment and performance bond(s) within a specified period of time. Note: Even though most bid bonds are for only 10% of the bid, the surety or bonding company recognizes the full bid due to the fact that if the contractor is the low responsive bidder, then the surety will be providing 100% Payment and Performance bonds.
Payment Bond (same as Labor and Materials Bond): Protects the owner/obligee by assuring payment for labor and materials associated with the project. Please note: Payment and Performance bonds are usually required in conjunction with Public contracts. Usually the owners of the contract will require a 100% Payment and a 100% Performance bond, though they may only require a 50% Payment Bond, or a 50% Performance Bond. There are no extra fees and/or costs associated with obtaining the two bonds, nor if the percentage changes from 100%, to only 50%. Again, there are no variations in cost.
Performance Bond (same as Faithful Performance Bond): Protects the owner/obligee from financial loss caused by contractor’s failure to complete the project. It guarantees payment of such things as cost of completion or cost to correct deficiencies, which are the responsibility of the contractor. Please note: Payment and Performance bonds are usually required in conjunction with Public contracts. Usually the owners of the contract will require a 100% Payment and a 100% Performance bond, though they may only require a 50% Payment Bond, or a 50% Performance Bond. There are no extra fees and/or costs associated with obtaining the two bonds, nor if the percentage changes from 100%, to only 50%. Again, there are no variations in cost.
Principal: The principal is the party that undertakes the obligation. (The contractor needing the bond is referred to as the “principal” on the bond). The surety guarantees the obligation will be performed.
Obligee (pronounced “ob – li – jee”): Is the party who receives the benefit of the bond. The city, other government agency requiring the bond, or a general contractor for subcontractors, is the Obligee on the bond.
OTHER TERMS AND QUESTIONS ON SURETY BONDING
What is a Surety Bond? A surety bond is a written agreement that usually provides for monetary compensation in case the principal fails to perform the acts as promised. There are many different types of surety bonds, but the two general categories are contract and commercial surety bonds.
Surety Bonding versus more common lines of insurance: In traditional insurance, the risk is transferred to the insurance company. In suretyship, the risk remains with the principal. The protection of the bond is for the obligee.
In traditional insurance, the insurance company takes into consideration that a certain amount of the premium for the policy will be paid out in losses.
In true suretyship, the premiums paid are “service fees” charged for the use of the surety company’s financial backing and guarantee.
In underwriting traditional insurance products the goal is “spread of risk.” In suretyship, surety professionals view their underwriting as a form of credit so the emphasis is on prequalification and selection.
What is Personal Indemnity? It is common for a surety to request the indemnity of the owners of a closely held corporation. Typically, the spouse’s indemnity also is required because personal assets are jointly owned. The two main reasons for this requirement are that the surety requires all personal assets to be available to back the guarantee and that there is less chance a principal will avoid its responsibilities if its personal assets are at stake.
How does collateral security relate to a surety bond? If an underwriter is unable to approve a bond request based on the qualifications given by the principal, the company may suggest depositing some form of collateral as an inducement to write the bond. In practice, many bonds are written on this basis, particularly ones that are considered financial guarantees.
Forms of collateral: Only certain bonding companies will allow collateral to be used to secure a bond. The types of collateral allowed vary from one company to another. However, typically the following three forms are usually acceptable: Certificates of Deposit, Irrevocable Letter of Credit, and the use of Real Estate.
Broker: Individual or organization representing a contractor in soliciting, negotiating or buying a surety bond and rendering services incidental to these functions. By law, a broker also may be allied with the surety company for certain purposes, such as delivery of a bond or collection of payment. R S Bonding & Insurance Agency, Inc. is a broker.
Contractual Liability: Liability assumed under a written contract.
Discovery Period: Under certain surety bonds, the time allowed to discover, after termination of the bond, that a loss has occurred. The terminated bond covers the loss if it is discovered during the specified time period.
Environmental Remediation Contract: A broad class of construction contracts covering remediation of environmental damage.
Fiduciary: A corporation, person or other entity who occupies a position of trust; especially one who manages another’s affairs.
General Indemnity Agreement (GIA): Agreement by which one party agrees to indemnify a second party for losses suffered by the second party.
Non-Compliance: Failure to obtain surety bonding for a public project. Board members of public entities have been held personally responsible for losses resulting from defaults by contractors who should have been covered by surety bonds.
Premium: Payment required for surety bonds.
Pre-qualification: A rigorous review performed by the surety to certify that a contractor is capable of performing the work in accordance with the terms and conditions of the contract.
Producer: The agent/broker responsible for writing the surety bond.
Reinsurance: Insurance that involves acceptance by one insurer, called the re-insurer, of all or a part of the exposures covered by another insurer.
Risk: Possibility of loss or exposure to loss. Probability or chance of loss. Peril which may cause loss.
Risk Control: All methods of reducing the frequency and/or severity of losses including exposure avoidance, loss prevention and loss reduction.
Surety: A company licensed in one or more states to write surety bonds. The U.S. Treasury Department maintains a list of surety companies that
it has qualified to write surety bonds for U.S. Government projects. The surety stands ready to facilitate completion by: providing trained personnel to consult and solve problems; bringing in a completion contractor; paying subcontractors and suppliers and arranging financial assistance for the contractor.
Surety Bond: An agreement guaranteeing that a principal will carry out the contractual obligations the principal has agreed to perform or, alternatively, to compensate the other parties to the contract for losses resulting from the principal’s failure to perform. Under many surety bonds, the principal is a contractor.
Surety Bonding: The process of pre-qualifying the contractor (principal) and guaranteeing to the project owner (obligee) that the contractor will fulfill the contract’s terms and conditions and pay subcontractors and suppliers.
Surety Credit: Contractors qualify for surety credit following an analysis of their financial statements, integrity and abilities by the surety underwriter.
Surety Underwriter: An employee of the surety company who evaluates applications for surety bonds and determines the terms under which the applicant will be bonded.
Suretyship: An extension of credit without funds being dispersed (unless there is a default by the contractor principal on the bonds.) The surety is the third party to whom an owner (obligee) can turn if a contractor fails or cannot perform its obligations.