urety bonds are a major industry in America. In general terms, this is the business of having a third party guarantee that a contracted party will live up to the terms of the contract or pay a penalty. Therefore, they are not legally or technically a form of insurance, but as a practical matter they do insure and guarantee that a contract will be fulfilled.
Definition
A surety bond is a contract among three separate parties. There is the principal, a person who will perform a set act. There is the obligee, a person who is the recipient of the principal's action. Finally, there is the surety, a person who is obliged to guarantee that the principal does what he is contracted to do. If the principal fails to follow through, the surety must step into the principal's place. In a legal sense, surety bonds are not insurance policies, but as a practical matter they do offer a form of insurance in the role of guaranteeing that a contract will be fulfilled. All surety bonds include a "penal sum," which defines the responsibility of the surety and principal. This usually includes an amount of money but may also include duties.
Types
A bid bond guarantees the obligee that the principal will sign all contract-related documents if they win a bid process and are awarded a contract. Basically, if the principal bids on a job, wins the job and balks at signing all relevant agreements, both the contractor and the surety become liable. Terms typically include payment of a sum based on what the estimate of doing another round of bids will cost.
A performance bond is a guarantee that the principal will complete the contract according to the set terms, especially relating to price and time. Once again, the surety is liable along with the principal. These bonds give the surety three choices: seeing the contract completed; joining the obligee in selecting a new contractor to finish the task; or allowing the obligee to finish the task, with costs paid by the surety.
A payment bond guarantees that subcontractors and suppliers will be paid by the principal. In this case, the beneficiary of the bond is not the obligee but the subcontractors. However, this benefits the obligee by directing the ire of unpaid subcontractors toward the surety rather than himself.
Function: Construction Industry
All thee types of surety bonds are nearly universal in the construction industry. However, despite their ubiquity, and while nearly all contractors know how to go about getting a surety bond, many small business owners in construction are not familiar with the specific legal obligations between the three basic parties involved. Therefore, just because the contractor renovating your kitchen is "bonded," it doesn't mean he understands his obligations under that bond.
While surety bonds function might seem to be a form of insurance, in legal terms, they are definitely not insurance. It is a guarantee that a given contract will be fulfilled.
Surety "Insurance" as an Industry
An industry has grown up in America for providing the role of surety. The first company to provide this service was the United States Fidelity and Casualty Company of New York, established in 1880. Surety is now a major industry, bringing in premiums totaling $3.5 billion per year according to their trade association.
Surety for the Government
According to Federal law, all U.S. government contracts exceeding $100,000 require payment and performance bonds. U.S. government agencies are required to seek suitable alternatives to surety bonds for contracts between $25,000 and $100,000. Other surety bonds may be required, depending on the contract.
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