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
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
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
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
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
Fiduciary - A corporation, person or other
entity who occupies a position of trust; especially one who manages another's
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.
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