A surety bond or surety is a promise to pay one party a certain amount if a second party
fails to meet some obligation, such as fulfilling the terms of a contract.
The surety bond protects the obligee against losses resulting from the principal's failure
to meet the obligation.
Overview A surety bond is defined as a contract among
at least three parties: the obligee - the party who is the recipient
of an obligation the principal - the primary party who will
perform the contractual obligation the surety - who assures the obligee that
the principal can perform the task European surety bonds are issued by banks
and are called "Bank Guaranties" in English and Cautions in French.
They pay out cash to the limit of guaranty in the event of the default of the Principal
to uphold his obligations to the Obligee, without reference by the Obligee to the Principal
and against the Obligee's sole verified statement of claim to the bank.
Through a surety bond, the surety agrees to uphold — for the benefit of the obligee
— the contractual promises made by the principal if the principal fails to uphold its promises
to the obligee.
The contract is formed so as to induce the obligee to contract with the principal, i.e.,
to demonstrate the credibility of the principal and guaranty performance and completion per
the terms of the agreement.
The principal will pay a premium in exchange for the bonding company's financial strength
to extend surety credit.
In the event of a claim, the surety will investigate it.
If it turns out to be a valid claim, the surety will pay and then turn to the principal for
reimbursement of the amount paid on the claim and any legal fees incurred.
If the principal defaults and the surety turns out to be insolvent, the purpose of the bond
is rendered nugatory.
Thus, the surety on a bond is usually an insurance company whose solvency is verified by private
audit, governmental regulation, or both.
A key term in nearly every surety bond is the penal sum.
This is a specified amount of money which is the maximum amount that the surety will
be required to pay in the event of the principal's default.
This allows the surety to assess the risk involved in giving the bond; the premium charged
is determined accordingly.
Surety bonds also occur in other situations, for example, to secure the proper performance
of fiduciary duties by persons in positions of private or public trust.
As of 2009 annual US surety bond premiums amount to approximately $3.5 billion.
State insurance commissioners are responsible for regulating corporate surety activities
within their jurisdictions.
The commissioners also license and regulate brokers or agents who sell the bonds.
History Individual surety bonds represent the original
form of suretyship.
The earliest known record of a contract of suretyship is a Mesopotamian tablet written
around 2750 BC.
Evidence of individual surety bonds exists in the Code of Hammurabi and in Babylon, Persia,
Assyria, Rome, Carthage, among the ancient Hebrews and in England.
The Code of Hammurabi, written around 1790 BC, provides the earliest surviving known
mention of suretyship in a written legal code.
The first Corporate Surety, the Guarantee Society of London, dates from 1840.
In 1865, the Fidelity Insurance Company became the first US Corporate Surety company, but
the venture soon failed.
Contract surety bonds Contract bonds, used heavily in the construction
industry by general contractors as a part of construction law, are a guaranty from a
Surety to a project's owner that a general contractor will adhere to the provisions of
a contract.
The Associated General Contractors of America, a United States trade association, provides
some information for their members on these bonds.
Contract bonds are not the same thing as contractor's license bonds, which may be required as part
of a license.
Included in this category are: bid bonds, performance bonds, payment bonds, and maintenance
bonds.
There are also miscellaneous contract bonds that do not fall within the categories above,
the most common of which are subdivision and supply bonds.
Bonds are typically required for federal government projects by the Miller Act and state projects
under "little Miller Acts".
In federal government, the contract language is determined by the government.
In private contracts the parties may freely contract the language and requirements.
Standard form contracts provided by American Institute of Architects and the Associated
General Contractors of America make bonding optional.
If the parties agree to require bonding, additional forms such as the performance bond contract
AIA Document 311 provide common terms.
Losses arise when contractors do not complete their contracts, which often arises when the
contractor goes out of business.
Contractors often go out of business; for example, a study by BizMiner found that of
853,372 contracts in the United States in 2002, 28.5% had exited business by 2004.
The average failure rate of contractors in the United States from 1989 to 2002 was 14
percent versus 12 for other industries.
Prices are as a percent of the penal sum ranging from around one percent to five percent, with
the most credit-worthy contracts paying the least.
The bond typically includes an indemnity agreement whereby the principal contractor or others
agree to indemnify the surety if there is a loss.
In the United States, the Small Business Administration may guaranty surety bonds; in 2013 the eligible
contract tripled to $6.5 million.
Commercial surety bonds Commercial bonds represent the broad range
of bond types that do not fit the classification of contract.
They are generally divided into four sub-types: license and permit, court, public official,
and miscellaneous.
License and permit bonds License and permit bonds are required by certain
federal, state, or municipal governments as prerequisites to receiving a license or permit
to engage in certain business activities.
These bonds function as a guaranty from a Surety to a government and its constituents
that a company will comply with an underlying statute, state law, municipal ordinance, or
regulation.
Specific examples include: Contractor’s license bonds, which assure
that a contractor complies with laws relating to his field.
In the United States, bonding requirements may be at federal, state, or local level.
Customs bonds, including importer entry bonds, which assure compliance with all relevant
laws, as well as payment of import duties and taxes.
Tax bonds, which assure that a business owner will comply with laws relating to the remittance
of sales or other taxes.
Reclamation and environmental protection bonds Broker’s bonds, including Insurance, Mortgage,
and Title Agency bonds ERISA bonds
Motor vehicle dealer bonds Money transmitter bonds
Health spa bonds, which assure that a health spa will comply with local laws relating to
their field, as well as refund dues for any prepaid services in the event the spa closes.
Court bonds Court bonds are those bonds prescribed by
statute and relate to the courts.
They are further broken down into judicial bonds and fiduciary bonds.
Judicial bonds arise out of litigation and are posted by parties seeking court remedies
or defending against legal actions seeking court remedies.
Fiduciary, or probate, bonds are filed in probate courts and courts that exercise equitable
jurisdiction; they guaranty that persons whom such courts have entrusted with the care of
others’ property will perform their specified duties faithfully.
Examples of judicial bonds include appeal bonds, supersedeas bonds, attachment bonds,
replevin bonds, injunction bonds, Mechanic's lien bonds, and bail bonds.
Examples of fiduciary bonds include administrator, guardian, and trustee bonds.
Public official bonds Public official bonds guaranty the honesty
and faithful performance of those people who are elected or appointed to positions of public
trust.
Examples of officials sometimes requiring bonds include: notaries public, treasurers,
commissioners, judges, town clerks, law enforcement officers, and Credit Union volunteers.
Miscellaneous bonds Miscellaneous bonds are those that do not
fit well under the other commercial surety bond classifications.
They often support private relationships and unique business needs.
Examples of significant miscellaneous bonds include: lost securities bonds, hazardous
waste removal bonds, credit enhancement financial guaranty bonds, self–insured workers compensation
guaranty bonds, and wage and welfare/fringe benefit bonds.
Fidelity bonds Fidelity bonds, also known as employee dishonesty
coverage, cover theft of an employer's property by its own employees.
Though referred to as bonds, fidelity coverage functions as a traditional insurance policy
rather than a surety bond.
See also Surety
Co-signing Demand guarantee
Fidelity bond Fiduciary
Indemnity Insurance
Performance bond Submittals
Shop drawing Testator
References
External links Surety Bonds at DMOZ