Although they are vital to completing a project quickly and efficiently, an unqualified subcontractor can have a negative impact on the entire project. To counter these risks, owners may require a surety bond to provide coverage for subcontractor failures. Surety bonds serve to:
- Relieve the project owner from financial loss as a result of liens for unpaid subcontractors and suppliers. They also protect taxpayer money for public projects.
- Ease the transition between construction and permanent financing by removing the threat of unresolved liens.
- Offer technical, managerial and financial assistance to move the project along and reduce the chance of default.
- Arrange for project completion if the contractor defaults.
A surety bond is a written agreement that includes three parties:
- The principal is the party that undertakes the obligation.
- The surety company guarantees the obligation will be performed.
- The obligee is the party who receives the benefit of the bond.
There two main types of surety bonds, contract (or corporate) surety bonds and commercial surety bonds.
Contract (or Corporate) Surety Bonds
Contract (or corporate) surety bonds provide financial security and construction assurance for building and construction projects by assuring the project owner (obligee) that the contractor (principal) will perform the work and compensate certain subcontractors, laborers and material suppliers, as outlined via their contract. Contract surety bonds include the following:
- 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.
- Maintenance bonds guarantee against defective workmanship or materials for a specified period.
- Subdivision bonds make guarantees to cities, counties or states that the principal will finance and construct certain improvements such as streets, sidewalks, curbs, gutters, sewers and drainage systems.
Commercial Surety Bonds
Commercial surety bonds guarantee performance by the principal of the obligation or undertaking described in the bond. Commercial surety bonds include the following:
- License and permit bonds are required by state law or local regulations in order to obtain a license or permit to engage in a particular business (e.g., contractors, motor vehicle dealers, securities dealers, employment agencies, health spas, grain warehouses, liquor and sales tax).
- Judicial and probate bonds, also referred to as fiduciary bonds, secure the performance on a fiduciaries’ duties and compliance with court orders (e.g., administrators, executors, guardians, trustees of a will, liquidators, receivers and masters). Judicial proceedings court bonds include injunction, appeal, indemnity to sheriff, mechanic’s lien, attachment, replevin and admiralty.
- Public official bonds guarantee the performance of duty by a public official, (e.g., treasurers, tax collectors, sheriffs, judges, court clerks and notaries).
- Federal (non-contract) bonds are required by the federal government (e.g., Medicare and Medicaid providers, customs, immigrants, excise, and alcoholic beverage).
- Miscellaneous bonds include lost securities, lease, guarantee payment of utility bills, guarantee employer contributions for union fringe benefits and workers’ compensation for self-insurers.
How is Suretyship Different?
Key differences exist between suretyship and other insurance:
- In traditional insurance, the risk is transferred to the insurance company. However, in a suretyship, the risk remains with the principal and the protection of the bond is designated for the obligee.
- In traditional insurance, the insurance company assumes that part of the premium for the policy will be paid out in losses. Yet, 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 to “spread the risk,” while in a suretyship, surety professionals view their underwriting as a form of credit. Therefore, the emphasis is on the pre-qualification and selection process.
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