Many people asked the question: What is a surety bond? A surety bond is a written agreement between three parties; The Principal, the obligee and the Surety Company. The Surety Company obligates itself to the obligee (project owner), to be responsible for the default of the Principal (contractor). The Principal is the one required to provide a bond.
A Contract Surety Bond provided by the Surety Company gives financial security to the project owner (obligee) assuring that the contractor (principal) will perform and complete the construction project and pay certain subcontractors, laborers, and material suppliers.
Commercial Surety Bonds guarantee that the principal will perform the obligation or undertaking described in the bond.
Does suretyship differ from insurance? Regarding insurance, the insurance company indemnifies the insured against loss. An example would be, if the insured incurs a loss by fire and has purchased the correct and appropriate insurance coverage, the insurance company will reimburse the insured for their loss up to the insurance policy limit.
With a bond it is different. The insurance company (surety) will reimburse a third party (obligee) for the loss caused to them by the (principal). If the surety is required to pay the obligee on behalf of the principal because of a loss on the bond, the principal is required to reimburse the surety for the loss. A surety is essentially extending credit to the principal. The surety company is not insuring the principal against loss.
Contract Surety Bonds are most often used by contractors. They provide financial security and construction assurance on the contracted construction projects by assuring the project owner (obligee) that the contractor (Principal) is qualified to perform the work and is financially able to and will pay certain subcontractors, laborers, and material suppliers.
Contract Surety Bonds include:
Bid bonds: provide financial assurance that the bid has been submitted in good faith, and that the contractor (principal) intends to enter into the contract at the price bid and provide the required performance and payment bonds.
Performance bonds: protect the project owner (oblige) from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions.
Payment bonds: guarantee that the contractor (principal) 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: are a guarantee to a city, county, or state that the principal will finance and construct certain improvements such as street, sidewalks, curbs, gutters, sewer, and drainage system.
What criteria is used by a surety during the underwriting process? A surety looks at specific criteria to determine if the contractor is qualified to perform the contract. A bond will not be issued until the surety is satisfied of a contractor’s:
Good character, Experience matching contract requirements, Financial strength, Acceptable credit history, Banking relationship - line of credit and If the contractors owns or has the ability to obtain the necessary equipment to carry out the contract.
In short, the surety company’s prequalification provides assurances that the contractor runs a well-managed, profitable enterprise, deals fairly, and performs obligations as agreed.