SURETY BONDS
A Surety Bonds Primer:
What Are Surety Bonds
And How Do They Work?
A
surety bond is a three-party
agreement that guarantees
specific obligations are
fulfilled. The parties
involved are the principal,
the obligee, and the surety. The principal
is the individual or business that obtains
the bond, the obligee is the entity that
requires the bond, and the surety is the
insurance company that backs the bond.
Although there are numerous types
of surety bonds, the most commonly
required bonds are construction
contract bonds (also known as payment
and performance bonds). The obligee
(construction project owner) will require
the principal (contractor) to provide
payment and performance bonds. These
bonds guarantee that the principal will
complete the project per the terms and
conditions of the contract and pay any
bills directly related to the labor and
materials required to complete the
work. In the event the principal fails to
complete the contract or pay for any labor
or materials, a claim can be made on the
bonds. Unlike an insurance policy, the
principal is required to repay in full any
claims payments (as well as legal costs)
incurred by the surety.
In essence, surety bonds are as much
a form of insurance to the obligee as
they are to the beneficiary. But unlike
insurance, surety bonds are also a form of
credit to the principal as any claims and
legal costs must be repaid by the principal
30
to the surety. The bond is backed by
the surety, but the surety requires an
indemnity agreement to be signed by the
company and all owners personally.
The surety company prequalifies the
contractor, providing peace of mind to
the other project participants including
the owner, lender, material suppliers,
and work crew. The screening process
is rigorous, with an exhaustive review
of a contractor’s references, job history,
equipment access, financial strength,
credit history, and bank relationships.
Contractors who want access to large
projects need to work to cultivate a solid
track record, requiring considerable
planning, effort, and discipline. They
must carefully manage their finances, be
mindful of their company’s capacity to
complete work, pay subcontractors on
time, not take on more jobs than they
can handle, and have a track record of
completing projects on time and within
the terms and conditions of the contract.
These accomplishments demonstrate the
ability to successfully manage a company,
along with good business decision-making
skills.
The great thing about having a surety
bond program in place is that it ca