Surety Bonds

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What is a surety bond?

A surety bond is a three party agreement, which legally binds together the party needing the bond (principal), the party requiring the bond (obligee) and a surety company providing the bond. The surety company guarantees that the obligations of the principal to the obligee will be performed in accordance with a contract, statute or regulations. Bonds are used to protect public and private funds from financial loss.

Who is the principal?

This is the person or business who is required to be bonded by the Oblige. The Principal is obligated to the Oblige to pay and/or perform according to a law, ordinance, rule, regulation, contract, license or permit. Who is the Oblige? This is the party that requires the Principal to provide the bond. The Oblige is protected from loss by the Surety if the Principal fails to fulfill their obligations.

Who is the surety?

This is the insurance company that issues the bond for the Principal. In doing so, they are guaranteeing the obligations of the Principal.

How is a bond different from insurance?

A surety bond and an insurance policy are not the same. Surety bonds are credit instruments – not insurance policies. The surety indemnity agreement gives the surety the right to go back to the company and any personal indemnitors to collect what they may have paid out. For insurance, the costs of assumed losses are calculated into the price of an insurance policy premium. A bond is an extension of credit with the expectation that the legal obligation will be fulfilled, and subsequently, there will be no loss. Losses are not included in the cost of bond premiums, only underwriting expenses are factored into the rates.

What are the benefits of surety bonds?

Surety bonds are a mechanism for transferring risk. The surety company assumes the risk of the principal doing business from the obligee. Federal, state and local governments generally require surety bonds to give certainty that business owners and individuals will adhere with various laws safeguarding public funds. For example, license bonds protect the public from business impropriety. Contract bonds protect taxpayers by pledging that projects are finished appropriately, on time and without liens. Court, public official, government and miscellaneous bonds protect and secure public funds and private interests.

Why do surety bonds need to be underwritten?

A surety company must determine the risk of a loss occurring if the principal is unable to satisfy the obligation under the bond. Since a bond is an extension of credit, the surety company must review the principal’s financial information and business experience to determine if certain requirements are met to support the bonded obligation. This procedure is known as the underwriting process. Just as a bank evaluates loan applications, surety company underwriters evaluate risks in a similar way by considering business and personal financial statements, credit reports, credit references and other factors.

What is indemnity?

Indemnity agreements are a standard of the surety industry. To indemnify means to make whole. Under common law, the surety company has the right to be indemnified by the principal in the event of a loss. The General Indemnity Agreement (GIA) carries out that right by stating that if the surety suffers a loss while providing a bond to the principal, the principal is obligated to make the surety “whole” by reimbursing any losses and expenses. Surety companies usually require the president to sign on behalf of the company, all owners with over 10% ownership to sign personally, and the owners’ spouses to sign personally. Personal indemnification establishes the principal’s private commitment to the business entity and to the surety company.

Why does the surety require spousal indemnity?

Often, a principal states they do not want their spouses to sign the indemnity agreement. They make the argument that they created the corporation to protect themselves personally. 1. The surety does not want corporate assets transferred to a spouse after a claim has been filed. 2. In the event the surety needs restitution and the business is no longer in operation, they then look to the owners for it. 3. If there is a divorce and the now ex-wife gets the business the surety needs to make sure they have all appropriate indemnity already in place.

Why do I need to produce collateral to obtain a surety bond?

A surety company has a right to request collateral to reduce the risk of the bond. Collateral is occasionally required for high-risk principal’s or abnormal obligations. Collateral reduces the risk a surety company assumes when issuing a bond. Collateral can be provided in many forms, including cashier’s checks, cash, or irrevocable letters of credit. Collateral is returned to the principal only after all bond obligations have been met and the oblige releases the surety company from their obligation.