Surety Bonds are a risk transfer mechanism. The risk of doing business with the principal is shifted from the Obligee to the Surety company. Federal, State and Local governments often require surety bonds to guarantee that business owners and individuals will comply with various laws protecting public funds. For example, license bonds protect the public from business misconduct. Contract bonds protect taxpayers by guaranteeing that projects are completed properly, on time and without liens. Court, Public Official, Government and Miscellaneous bonds protect and secure public funds and private interests.
To “Indemnify” means to make whole. Under common law, the Surety Company has the right to be indemnified by the Principal in the event of a loss. The General Indemnity Agreement (GIA) enforces that right by stipulating that if the surety suffers a loss while providing a bond to the Principal, the Principal is obligated to make the Surety “whole” by reimbursing any losses and expenses due to claims. All owners, partners and stockholders and spouses are usually required to sign the GIA . Personal indemnification demonstrates the Principal’s personal commitment to the business entity and to the surety company as well.
A Surety Company must determine the probability of a loss should the Principal be unable to complete their obligations under the bond. Since a bond is an extension of credit, the Surety Company must analyze the Principal’s financial condition and business aptitude to determine if the Principal has the business knowledge and financial strength to support the bond obligation. This is part of the “Underwriting” process. Surety Underwriters evaluate risks in ways that are similar to a bank underwriting a loan application. Business and personal financial statements, credit reports, credit references and other factors are considered when a Surety is underwriting for a bond.
The Surety Company may request that you post collateral to reduce the risk of the bond. Collateral can be required due to high risk bond types, high risk principals or unusual obligations. Collateral can be taken in the form of a Cashier’s check or an Irrevocable Letter of Credit (ILOC) from an approved bank. The Surety will supply a sample of their ILOC for the bank to use. After all obligations of the bond have been met and all statutes have passed or the Obligee issues a release or exoneration letter to the surety, the collateral is then returned to the principal or owner of said collateral.
Suretyship is a very specialized line of insurance that is created whenever one party guarantees performance of an obligation by another party. There are three parties to the agreement:
A surety bond is a written agreement that usually provides for monetary compensation in case the principal fails to perform the acts as promised. There are many different types of surety bonds, but the two general categories are contract and commercial surety bonds.