What is a SURETY Bond?

This is the definition as presented by the Merriam-Webster web site.
Main Entry: sure·ty Pronunciation: \ˈshu̇r(-ə)-tē\
Function: noun   Inflected Form(s): plural sure·ties   (1): the state of being sure: as a: sure knowledge : certainty b: confidence in manner or behavior : assurance (2) a: a formal engagement (as a pledge) given for the fulfillment of an undertaking : guarantee b: a basis of confidence or security (3): one who has become legally liable for the debt, default, or failure in duty of another.

All three of these definitions are intended when surety bonds are used. Surety has been used as a means of protection since the beginning of time. The word surety is mentioned several times in the King James Version, of the Bible, including the oldest book of the Bible, Job. Surety is used throughout the Bible while meaning one or more of the definitions above. Most of the surety backing during those times was provided by individuals. It wasn’t until the mid 1800’s that corporations became involved in providing surety.

Surety bonds are backed, or guaranteed, generally by insurance companies. These companies are usually monitored by each state and have regulations that must be met before they are permitted to perform business. There is also a method called personal surety where a single or group of investors may personally back or guarantee the performance or obligation of one whom is bonded. Even though insurance companies provide the bonds the bond is not insurance. Insurance, as typically defined, is designed to compensate or make whole the insured in the event certain hazards cause a lost. The policy and premium is based on the percentage of possibility of a loss occurring. Surety is arranged to prevent a loss. The contractor is pre-qualified based on the financial position and experience. The premium for surety bonds are based on the presentation of the contractor and the risk of default.

Surety companies resemble construction companies in a certain way. Picture a triangle. At the bottom of the triangle there are many contactors that can perform $100,000 contracts. As you move up the triangle the size of the contract increases the number of contractors able to perform the work decreases. The same is said for surety companies; there are many sureties that can guarantee $100,000 bonds, less that can back $10,000,000 contractors, and even fewer that can write $100,000,000 bonds. So, the larger the contractor the more structured the program and the fewer sureties there are to provide bonding.

What is a BOND?

A contract surety bond is a three-party agreement (contract) where the surety company assumes the risk and assures the owner (obligee) that the contractor (principal) will perform the duties under the contract between the owner and contractor. Basically, a surety bond guarantees the contractor will perform the contract and pay the bills and if not, the surety is obligated with this task at the contract price.

The main types of bonds used in construction are; bid bond, performance bond, payment bond, and maintenance bond.

• The bid bond supplies assurance, to the owner, that a surety company has qualified the bidder and that a good faith estimate to perform the contract at the price presented has been given. The bid bond also assures the owner that a performance and/or payment bond will be provided in the event the project is awarded to the bidder. Most bid bonds have a percentage assigned to them; such as, a 5% bid bond. This means that the percentage of the bid may be forfeited if the bidder can not provide the necessary bonds at the time the contract is awarded.
• The performance bond protects the owner and guarantees that the duties of the contract will be performed even in the event of a default on the contractor. This bond offers assurance, to the owner, that the contract will be performed in accordance to the terms and conditions at no additional cost should the contractor fail to perform.
• The payment bond provides certainty that all cost pertaining to the contract will be paid to the workers, subcontractors, and material suppliers in the event the contractor fails to make payment.
• The maintenance bond is usually worded in the performance bond, but can be separate. This bond guarantees that after the project is complete if the contractor cannot supply maintenance the surety company will for the length of time specified in effective and expiration dates.

In order for a contractor to become “bonded” they must go through a qualification process. This process is similar to acquiring a bank loan. As a matter of fact, bonding is more of a financial responsibility than insurance. This qualification is a process to determine if the contractor has the where-with-all, ability, and operations to perform the task required that could be involved in a construction contract. A contractor is measured on certain criteria, such as;

• Financial position
• Credit history
• References
• Experience
• Reputation
• Bank relationship

To undergo this qualification process there will be certain information that may be requested by the surety company;

• Information about the company and its owners; including personal information.
• Three previous fiscal year end financial statements on the construction company to become bonded.
• Three previous years personal and company tax returns
• A resume’ on the owners and key personnel
• Bank Letter of Reference stating the relationship is in good standing and minimal account balance information
• Current Insurance Certificate
• References

Once this information is provided the surety company can underwrite the company and make bonding decisions based on the data presented. The previous fiscal year end financial statement provides the current year bond program. That means the bond program is arranged according to the performance of the company in the previous year. Additional financial statements may be required throughout the current year to inform the surety company as to how the contractor is performing.

Becoming bonded is not a difficult undertaking. Bonding is a disciplined effort to follow a standard set of procedures and principles.