Surety Bond Basics
A surety bond is a promise to pay one party (the obligee) a certain amount if a second party (the principal) 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.
A surety bond is a contract among at least three parties:
- Obligee: The party who is the recipient of an obligation
- Principal: The primary party who will be performing the contractual obligation
- Surety: The party who assures the obligee that the principal can perform the task
Contract surety bonds include three primary types:
- Bid bonds: Provide financial assurance that the bid has been submitted in good faith, and that the contractor intends to enter into the contract at the price bid and provide the required performance and payment bonds.
- Performance bonds: Protect the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions.
- Payment bonds: Guarantee that the contractor will pay certain subcontractors, laborers, and material suppliers associated with the project.
- The surety company uses its financial resources to provide assurance to the obligee that the contractor will fulfill the obligations in the contract.
- The surety company charges a fee, known as the bond premium, for underwriting or pre-qualifying the contractor.
- The surety company completes an extensive prequalification process of the contractor to assure the contractor has the character, capacity, and the capital available to fulfill the contract.
- In the event of contractor default, the surety will conduct an investigation into information provided by all parties involved before taking action. The options of the surety may include financing the original contractor or providing support to finish the project, arrange for a new contractor to complete the project, assume the role of contractor and subcontractor work out to be completed, or pay the penal sum of the bond.
Functions of Surety
- Assure project completion
- Assure a qualified contractor is on the project
- Guarantee laborers, suppliers and subcontractors will be paid
- Reduce owner's risk of a lien being placed on the project from unpaid suppliers, subcontractors, etc.
- Promotes contractor growth by increasing opportunities and providing advice
- May lower the cost of construction projects through the competitive bid process
- Ability to screen out contractors who are unqualified
Why Contractors Fail
Construction is a risky business and surety bonds provide security and assurance, to owners, that the contractors are capable of completing the work and paying subcontractors, laborers, and suppliers. The goal of surety companies is to minimize risk. Therefore, they are knowledgeable about events or signs which could lead to contractor failure. Below are some of the top causes of contractor failure.
- Over expansion or change in scope of business
- Inexperience with new types of work or inadequate training/experience of personnel
- Changes in ownership or key personnel within the company
- Financial management problems caused by improper accounting practices, inadequate costs and management systems, and estimating problems
- Economic instability due to sudden changes in the market
- Weather delays or poor site conditions
- Material, equipment, or skilled labor shortages
- Contract terms which may be time consuming and burdensome
Contact one of our independent insurance agents today to find out additional information about our bonds.
Content on this website represents only a brief description of bond products. Please check with your agent and read the policy for exact details.