The fashion in which owners evaluate and manage
risk on construction
projects and make fiscally responsible decisions
to ensure timely project
completion are keys to their success. No private
owner of a construction
project can afford to gamble on a contractor
whose responsibility is
uncertain, or who could end up bankrupt halfway
through the job.
Furthermore, no public agency using the low-bid
system in awarding
public works contracts can be sure the lowest
bidder is dependable.
So how can this area of "uncertainty"
be lessened? The answer lies in
suretyship.
What is Suretyship?
Suretyship is a 'very specialized line of
insurance that is 'created whenever
one party guarantees performance of an obligation
by another party.
What
is a Surety Bond?
A surety
bond is a written agreement where one
party, the surety, obligates itself to
a second party, the obligee, to answer
for the default of a third party, the
principal. There are many different types
of surety bonds, but the two primary categories
are as follows. Contract (or Corporate)
Surety Bond The Contract (or Corporate)
Surety Bond provides financial security
and construction assurance on building
and construction projects by assuring
the project owner (obligee), that the
contractor (principal), will perform the
work and pay certain subcontractors, laborers,
and material suppliers.
Contract surety
bonds include:
1. 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.
2. Performance bonds
protect the owner from financial loss
should the contractor fail to perform
the contract in accordance with its terms
and conditions.
3. Payment bonds guarantee
that the contractor will pay certain subcontractors,
laborers, and material suppliers associated
with the project.
4. Maintenance bonds
guarantee against defective workmanship
or materials for a specified period.
5. 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 Bond
The Commercial Surety Bond guarantees
performance by the principal of the
obligation or
undertaking described in the bond.
Commercial surety bonds include:
1. 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, (contractors, motor vehicle
dealers, securities dealers, Blue Sky
bonds, employment agencies, health spas,
grain warehouses, liquor, and sales
tax).
2. Judicial and probate
bonds, also referred to as fiduciary
bonds, secure the performance on fiduciaries'
duties and compliance with court orders,
(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).
3. Public official
bonds guarantee the performance of duty
by a public official, (treasurers, tax
collectors, sheriffs, judges, court
clerks, and notaries).
4. Federal (non-contract)
bonds are those required by the federal
government, (Medicare and Medicaid providers,
customs, immigrants, excise, and alcoholic
beverage).
5. Miscellaneous bonds
include lost securities, lease, guarantee
payment of utility bills, guarantee
employer contributions for Union fringe
benefits, and workers compensation for
self-insurers.
To gain a better understanding of how
the surety relationship works, it is
important to know whomakes up the agreement
and how surety compares with other forms
of insurance.
Who Are the Three
Parties That Make Up the Surety Agreement?
1. The principal is the
party that undertakes the
obligation,
2. The surety guarantees
the obligation will be
performed, and
3. The obligee is the
party who receives the benefit of
the bond.
How is Suretyship Like Other More
Common Forms of Insurance?
1. State insurance commissioners
regulate them both,
and
2. They both provide
for financial loss.
How is Suretyship Different from
More Common Forms of Insurance?
1. 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.
2. 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 guarantee.
3. In underwriting traditional
insurance products the goal is to "spread
the risk." In suretyship, surety
professionals view their underwriting
as a form of credit so the emphasis is
on pre-qualification and selection.
Since 1893, the U.S. Government has
required contractors on federal public
works contracts to obtain surety bonds
to guarantee that they will perform such
contracts and pay certain labor and material
bills. The current federal law mandating
surety bonds on federal public works is
known as the Miller Act. It requires performance
and payment bonds for all public work
contracts in excess of $100,000 and payment
protection, with payment bonds the preferred
method, for contracts in excess of $25,000.
Also, almost all 50 states, the District
of Columbia, Puerto Rico, and most local
jurisdictions have enacted similar legislation
requiring surety bonds on public works.
These generally are referred to as "Little
Miller Acts."
While surety bonds are mandated by law
on
public works projects to protect taxpayer
dollars,
the use of surety bonds on privately-owned
construction projects is at the owner's
discretion.
Alternative forms of financial security,
such as
letters of credit and self-insurance,
don't provide
the 100 percent performance or payment
protection of a surety bond or assure
that a
contractor is competent. With a surety
bond, the
risks of project completion are shifted
from the
owner to the surety company. For that
reason,
many private owners require surety bonds
from
their contractors to protect their company
and
shareholders from the enormous cost of
contractor failure. Subcontractors may
be
required to obtain bonds to help the prime
contractor manage risk, particularly if
the
subcontractor is a significant part of
the job or a
specialized contractor that is difficult
to replace.
How Do You Obtain
a Surety Bond?
Surety bonds are issued through surety
bond
agents and brokers who are knowledgeable
about
the surety and construction industries.
Surety
bond agents and brokers usually work in
agencies
that specialize in surety bonds or in
insurance
agencies that have a sub-specialty in
surety
bonds.
The professional surety, bond agent or
broker
usually maintains a business relationship
with
several surety companies, which enables
them to
match a contractor with an appropriate
surety
company. A good surety company and surety
bond producer will help a contractor maintain
and
increase its surety capacity.
While this document provides a good overview
of
the need and functionality of surety bonds,
only
through discourse with a seasoned, professional
surety bond agent or broker can you fully
understand the need for this valuable
insurance
product. Contact us today for more information.
