Unit 11- Surety Bonds

Describe a performance bond. Guarantees i____ to the obligee for any losses resulting from the principal's failure to complete the c____ work in accordance with specifications.

indemnification, contract

What kind of insurance are surety bonds? Surety bonds or Suretyship is not i____. Although suretyship is transacted within the structure of the property and liability insurance business, there are important d____.

insurance, differences

What is a blue sky bond? This bond is required of _i____ companies guaranteeing against _m____ of securities and defrauding the public generally.

investment, misrepresentation

P____ - the one who undertakes to perform; O____ - the one who is to be guaranteed that the principal will perform; S____- the one who guarantees the performance of the principal to the obligee ("the bonding company").

Principal, Obligee, Surety

11.1b Suretyship vs. Insurance:

An additional difference is that in suretyship the third party making the guarantee has the right of recovery against the non-performer (the client or "insured" is required to reimburse the "insurer" for any losses paid). Recovery against those who default on a bond is known as "salvage." The one making the guarantee is only lending its credit to the transaction. In theory, there would be no losses under surety bonds. The bonding company would refuse to give a guarantee on behalf of one who may be unable to fulfill the obligation. Of course, there are losses. A third difference is that surety bonds are non-cancelable. The surety bond exists until completion of the contract.

11.3 The Bonding Process:

As previously discussed, in theory, there should be no losses under surety bonds. The surety company wants to satisfy itself that there will be no default once a bond is written. Depending upon the nature of the guarantee, the surety will wish to satisfy itself on: (1) The character of the principal (dependable reputation); (2) The principal's financial resources (capital); and (3) The experience or capabilities of the principal to perform the contract. These are frequently referred to as the 3 Cs; character, capital, capability. The surety may require a financially responsible indemnitor to guarantee the principal if the principal is lacking in financial resources. Another underwriting tool used by surety companies is "collateral." If the bond contains a financial guarantee (the principal will pay a given amount at some date or upon the happening of some contingency), the surety company may require that the bond be collateralized by depositing cash or other valuable property to be held by the surety for the lifetime of the bond; the collateral is returned to the principal when the obligation is fulfilled. Another underwriting tool to protect against loss is "joint control." Under this process, the surety company and principal exercise joint control over assets, and the surety company is further protected by the having to sign off on any disbursements. Once the surety company has underwritten the principal and agreed to write the bond, the bond is executed by an "attorney-in-fact." Agents for the surety company may be appointed as an "attorney-in-fact" or the surety company may have specialist in their employ execute the bond. Some forms of bonds are standard; some forms of bonds are written by the obligee. If there is a separate contract, frequently the contract itself becomes part of the bond. A contractor may check surety companies by using the U.S. Treasury Department List which shows for each surety company the maximum amount of bond acceptable from that surety company for any bond required by the federal government.

11.7b Miscellaneous Bonds:

Blue Sky Bond - This bond is required of investment companies guaranteeing against misrepresentation of securities and defrauding the public generally. U.S. Internal Revenue Bond - This type of bond is required of those who collect and must report taxes for certain control commodities (i.e. distilleries, winemakers, brewers and manufacturers of tobacco products). Customs Bond - A customs bond may be required of those who import or export goods. The bond guarantees that customs required by law will be collected, reported and paid.

11.5b Fiduciary and Court Bonds:

Conservation Bonds - This type of fiduciary bond is for those who are appointed to manage and preserve property other than estates of decedents (i.e. guardians of minors or incompetents). Insolvency Bonds - This type of fiduciary bond is required of persons appointed to conserve remaining assets and protect creditors (receivers and trustees for bankruptcy and insolvency proceedings). This type of bond may also be used for one who petitions the court to place another in bankruptcy (to guarantee reimbursement of expenses to the alleged bankrupt party if ultimately found not to be bankrupt).

Identify the type of bond (general classification and sub-classification, if applicable) that would be indicated for the following situation: " A developer is planning a major housing development on a large tract of land, and is seeking a permit from authorities to undertake the project"? The type of bond would be C____ - S____.

Contract - Subdivision

Identify the type of bond (general classification and sub-classification, if applicable) that would be indicated for the following situation: "A large company has negotiated an arrangement with a concrete company to provide concrete for its new home office building." The type of bond would be C____- S____ C____.

Contract - Supply Contract

Identify the type of bond (general classification and sub-classification, if applicable) that would be indicated for the following situation: "A contractor wishes to regain use of his equipment by a creditor who has secured a writ of attachment against the equipment"? The type of bond would be C____ - C____ - D____.

Court - Court - Defendants

Identify the type of bond (general classification and sub-classification, if applicable) that would be indicated for the following situation: "A court has appointed a person to wind up the affairs of a bankrupt company"? The type of bond would be C____- F____ - I____.

Court - Fiduciary - Insolvency

11.5c Fiduciary and Court Bonds:

Court Bonds - Both the plaintiffs and defendants in litigation are required to provide court bonds to protect the opposing party from loss in the event the principal fails to show a legal entitlement to the remedy sought. Some examples of plaintiff's bonds are: one seeking a writ of attachment against another, to prevent that person from disposing of the property in question; one seeking an injunction to restrain a person from doing a certain thing; or to protect one who has property of seized. Bail Bond - This is a type of court bond required by a defendant to guarantee his or her appearance in court. Other examples of defendant's bonds are: to get a release of the attachment when the plaintiff had secured a writ; to dissolve an injunction; to have seized property returned; and to appeal a judgment for money damages which have been awarded to the plaintiff.

11.5a Fiduciary and Court Bonds:

Fiduciary Bond - This bond guarantees the performance of a person appointed by a court, or named in a will or deed of trust to take possession of property, collect assets, make investments, pay debts, sell assets, carrying on a business, distribute property to heirs, or any combination of these and related task. The bond guarantees that the person will perform such tasks honestly and faithfully and make good to the court for any deficiencies the court finds in the performance. Probate Bond - The probate bond is a type of fiduciary bond designed for those who administer estates of deceased persons. These persons are required to collect the assets, file an inventory, give notice to creditors, paid the debts in proper order, distribute the balance to those entitled under law, and account to the court.

11.6a License and Permit Bonds:

License Bond - A license bond may be required by a public body for various reasons including a guarantee the licensee will operate in conformity with general laws. License bonds may also be required to protect the public against harm from unfair business practices or to guarantee the proper collection and payment of taxes. Indemnity Bond - This type of licensed bond holds a governmental body harmless from any injuries or damage caused by the principal's activities.

11.4a Contract Bonds:

Most surety bonds are issued for contract bonds, which are provided to guarantee the fulfillment of a contractual obligation, or for supplying material. Contract bonds are normally required on construction work for public entities. The majority of private construction work is not bonded, presumably because a private owner has greater latitude in choosing a contractor and the cost of the bond would be added to the contractor's price. There are four principal subclassifications of contract bonds: bid bonds, performance bonds, payment bonds and maintenance bonds. Bid Bond - This form of bond is required to accompany a bid for a contract, which will require a bond. The bid bond guarantees that if the bid is accepted, the bidder will enter into the contract and will be able to obtain a contract bond for the job. If the obligee awards the contract and the bidder refuses to perform the work (for example, because of an error in bid calculation) or is unable or unwilling to furnish the required contract bond, the bid bond guarantees to the obligee payment for the difference between the amount of that bid and the bid of another, which is accepted. The surety company who will ultimately furnish the contract bond provides the bid bond. The surety underwrites the bid bond in the same manner as the ultimate contract bond will be underwritten.

11.4b Contract Bonds:

Performance Bond - This bond guarantees indemnification to the obligee for any losses resulting from the principal's failure to complete the contract work in accordance with the contract. In many cases when a contractor defaults on the bond, the surety company will see the project through to completion. Sometimes the surety company will have another contractor complete the work with the surety paying the costs thereof; the surety company may call in another contractor to complete the work; or the surety company may pay the additional cost of letting the obligee find someone else to complete the work. Payment Bond - This bond guarantees that the contractor upon completion of the work will pay for all labor and materials for the project. This guarantees there will be no mechanic's liens or similar problems after completion. A payment bond is generally required when a performance bond is needed. Both a performance and payment bond are frequently combined as one bond. Maintenance Bond - If the contract requires the principal to be responsible after completion and acceptance of the work, to correct faulty work or replaced defective materials, a maintenance bond may be required. The maintenance portion of a bond may be included as a part of the performance and payment bond.

11.6b License and Permit Bonds:

Permit Bond - A permit bond is like a license bond except it deals with the requirement to get a permit for a specific function rather than a continuous operation (i.e. an athletic event, an exhibition, to move a building or to cut down a tree). Franchise Bond - This type bond is a variation of a license or permit bond which is required by a public body when it awards a franchise (i.e. a TV cable system, a transportation system or an electric, gas or telephone company).

11.7a Miscellaneous Bonds:

Public Official Bonds - Many public officials both appointed and elected must provide bonds for their terms of office. The bond guarantee is specified in the law, which requires the bonds. Generally these bonds guarantee the principal will uphold the oath of office and faithfully perform the duties of the office. Lost Instrument Bond - When a person has lost a negotiable instrument such as stock certificates, bonds or similar instruments, a bond is generally required by the issuing company before the issuing company will reissue the document. The bond guarantees to hold the issuer harmless from any losses growing out of the lost instrument. If another party finds the lost instrument, the issuer may have to honor it for its face value. The issuer may specify an amount for the bond called a fixed penalty bond, or may require a guarantee of payment without limit called an open penalty bond. Self-Insurance Bond - This type of bond is provided to an authority as evidence of compliance with an insurance requirement. For example, a large employer who is self-insured for worker's compensation or auto liability may provide the bond to show compliance with state law and guarantee financial responsibility to respond to obligations of the law.

11.4c Contract Bonds:

Subdivision Bond - This bond may be required by a public authority to guarantee that promised streets, sidewalks, sewers, street lights and other required improvements will be installed when a contractor applies for a permit to build a subdivision. Supply Contract Bond - This bond guarantees delivery of goods or material at an agreed upon price.

11.2 Parties to a Bond:

The three parties to a contract of suretyship are: (1) Principal - the one who undertakes to perform, to fulfill a contract or to meet an obligation. (2) Obligee - the one who is to be guaranteed that the principal will perform. (3) Surety - the one who guarantees the performance of the principal to the obligee ("the bonding company.") At times there may be yet another party to a surety agreement, an "indemnitor." The indemnitor agrees to reimburse the surety for any loss it may suffer from having bonded the principal. Frequently, a bonding company will require principal owners of a company to individually agree to indemnify the surety on behalf of a corporation.

Describe a bid bond. True or False: This form of bond is required to accompany a bid for a contract, which will require a bond. The bid bond guarantees that if the bid is accepted, the bidder will enter into the contract and will be able to obtain a contract bond for the job.

True

Describe a fiduciary bond. True or False: This type of bond is one that guarantees the performance of a person appointed by a court, or named in a will or deed of trust to take possession of property, collect assets, make investments, pay debts, sell assets, carry on business, distribute property to heirs, or any combination of these related tasks, honestly, faithfully and make good to the court for any deficiencies found in the performance.

True

Describe a franchise bond. True or False: This type bond is a variation of a license or permit bond which is required by a public body when it awards a franchise (i.e. a TV cable system, a transportation system or an electric, gas or telephone company).

True

Describe a license bond. True or False: A public body for a variety of reasons may require a license bond. Such a bond may simply guarantee the licensee will operate in conformity with general laws. Others may be for the purpose of protecting the public against harm from unfair business practices. The bond may guarantee the proper collection of payment of taxes.

True

Describe a maintenance bond. True or False: This bond may be required, if by specifications or operation of law, and if the principal is responsible after completion and acceptance to correct faulty work or replace defective materials; it guarantees such obligations will be met.

True

Describe a permit bond. True or False: A permit bond is like a license bond except it deals with the requirement to get a permit for a specific function rather than a continuous operation (i.e. an athletic event, an exhibition, to move a building or to cut down a tree).

True

Describe a probate bond. True or False: This is a type of fiduciary bond, which is designed for those who administer estates of deceased persons. Such persons are required to collect the assets, file an inventory, give notice to creditors, pay the debts in proper order, distribute the balance to those entitled under the law, and account to the court.

True

Describe conservation bonds. True or False: A type of fiduciary bonds for those who are appointed to manage and preserve property other than estates of decedents, such as those appointed as guardians of minors or incompetents.

True

Describe court bonds. True or False: Type of bond furnished by both the plaintiffs and defendants in litigation to protect the opposing party from loss in the event the principal fails to show a legal entitlement to the remedy sought. Some additional examples of use are; to protect the defendant against wrongful loss; and one seeking a writ of attachment against another, to prevent that person from disposing of the property in question.

True

Describe insolvency bonds. True or False: Type of fiduciary bond, required by persons appointed to conserve remaining assets and protect creditors. They are required of receivers and trustees for bankruptcy and insolvency proceedings, or for one who petitions a court to place another in bankruptcy (to guarantee reimbursement of expense to the alleged bankrupt party if ultimately found not to be insolvent).

True

Other than the use of an indemnitor, are there any other special underwriting tools for surety bonds? True or False: Collateral - If the bond contains a financial guarantee(a given amount at some date or on the happening of some contingency etc.), the surety may require that the bond be collateralized by the deposit of cash or other valuable property to be held by the surety for the lifetime of the bond, subject to return when the principal has fulfilled his obligation. Another tool to protect against loss is "joint control" wherein the surety and the principal exercise joint control over assets and disbursements.

True

What is a lost instrument bond? True or False: When a person has lost a negotiable instrument such as stock certificates, bonds or similar instruments, the issuing company generally requires a bond before the issuing company will reissue the document. The bond guarantees to hold the issuer harmless from any losses growing out of the lost instrument. If another party finds the lost instrument, the issuer may have to honor it for its face value. The issuer may specify an amount for the bond called a fixed penalty bond, or may require a guarantee of payment without limit called an open penalty bond.

True

What is a public official bond? True or False: Many public officials both appointed and elected must provide bonds for their terms of office. The bond guarantee is specified in the law, which requires the bonds. Generally these bonds guarantee the principal will uphold the oath of office and faithfully perform the duties of the office.

True

What is the general underwriting process before issuing a surety bond? True or False: Depending upon the nature of the guarantee, the surety will wish to satisfy itself on (1) the character of the principal (dependable reputation to warrant the surety's trust) (2) the principal's financial resources (capital) and (3) the experience or capabilities of the principal to perform.

True

11.1a Suretyship vs. Insurance:

Under a surety bond, a third party guarantees the fulfilling of an obligation by one party to another party. This is the first difference between suretyship and insurance; suretyship is a three party contract where insurance is a two party contract (insurer and insurer).

What is a U.S. Internal Revenue bond? This type of bond is required of those who c____ and must r____ taxes for certain control commodities (i.e. distilleries, winemakers, brewers and manufacturers of tobacco products).

collect, report

What is a self-insurance bond? This type of bond is provided to an authority as evidence of _c____ with an insurance requirement. For example, a large employer who is self-insured for worker's compensation or auto liability may provide the bond to show compliance with state law and guarantee financial responsibility to respond to _o____ of the law.

compliance, obligations

Describe a bail bond. This type of court bond would be required of a d____ to guarantee their a____ in court.

defendant, appearance

What are contract bonds in a suretyship? Contract bonds are the greatest e____ in suretyship, which are to provide a g____ for the fulfillment of a contractual obligation, particularly, an agreement for c____ and for s____ goods.

emphasis, guarantee, construction, supplying

What kind of companies provides surety bonds? Surety bonds may be written through companies specializing in that f____, but most business is written in m____ l____ companies, which maintain specialty departments for servicing surety bonds.

field, multiple line

Can the bonding company refuse to issue a surety bond? They will refuse to give a guarantee on behalf of one thought to be unable to f____ the o____, and if called upon, the bonding company would have the right of r____ against the defaulter.

fulfill, obligation, recovery

What is a customs bond? A customs bond may be required of those who import or export g____. The bond guarantees that c____ required by law will be collected, reported and paid.

goods, customs

Describe a payment bond. A payment bond guarantees that all l____ and m____ for the project will be paid by the c____ upon the completion of the work, which also guarantees there will be no mechanic's liens or similar problems after completion.

labor, materials, contractor

Describe an indemnity bond. An indemnity bond is a type of l____ bond, which holds a g____ body harmless from any injuries or damage caused by the principal's a____.

license, governmental, activities

Under what conditions would the bonding company usually require of an indemnitor? The surety may require an indemnitor if able to satisfy itself that the principal has the capabilities to perform the o____, but is lacking the necessary financial resources to carry it safely through to c____.

obligation, completion

Define one difference between suretyship and insurance? A surety bond, or suretyship, is one wherein the fulfilling of an o____ by one party to another is guaranteed by a t____ p____, a three-party contract, rather than two (insurer and insured).

obligation, third party

What is a recovery against those who default called in a suretyship? A default on o____ recovery, is called s____.

obligations, salvage

Describe a subdivision bond. This bond may be required by a p____ a____ to guarantee that p____ streets, sidewalks, sewers, streetlights and other required improvements would be i____.

public authority, promised, installed

Describe a supply contract bond. One who is p____ goods from another may require this bond, which guarantees d____ at an agreed price.

purchasing, delivery

What if the one who was to perform fails? If the one making the guarantee is called upon to pay because of default by the one who was to perform, the right of r____ exists against the non-performer. In this sense, the one making the guarantee is only l____ its credit to the transaction..

recovery, lending