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Surety bond

Surety bond

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A surety bond is a promise to pay one party (the obligee) a certain amount if a second party (the principal) fails to meet some obligation, such as fulfilling the terms of a contract. The surety bond protects the obligee against losses resulting from the principal's failure to meet the obligation.

Overview


A surety bond is a contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...

 among at least three parties:
  • The obligee - the party who is the recipient of an obligation,
  • The principal - the primary party who will be performing the contractual obligation,
  • The surety
    Surety
    A surety or guarantee, in finance, is a promise by one party to assume responsibility for the debt obligation of a borrower if that borrower defaults...

     - who assures the obligee that the principal can perform the task


European surety bonds are issued by banks and are called "Bank Guarantees" in English and "Caution" in French. They pay out cash to the limit of guarantee in the event of default of Principal to uphold his obligations to Obligee, without reference by Obligee to Principal and against obligee's sole verified statement of claim to the bank.

Through a surety bond, the surety agrees to uphold — for the benefit of the obligee — the contractual promises (obligations) made by the principal if the principal fails to uphold its promises to the obligee. The contract is formed so as to induce the obligee to contract with the principal, i.e., to demonstrate the credibility of the principal and guarantee performance and completion per the terms of the agreement.

The principal will pay a premium (usually annually) in exchange for the bonding company's financial strength to extend surety credit. In the event of a claim, the surety will investigate it. If it turns out to be a valid claim, the surety will pay it and then turn to the principal for reimbursement of the amount paid on the claim and any legal fees incurred.

If the principal defaults and the surety turns out to be insolvent
Insolvency
Insolvency means the inability to pay one's debts as they fall due. Usually used to refer to a business, insolvency refers to the inability of a company to pay off its debts.Business insolvency is defined in two different ways:...

, the purpose of the bond is rendered nugatory. Thus, the surety on a bond is usually an insurance company whose solvency is verified by private audit, governmental regulation, or both.

A key term in nearly every surety bond is the penal sum. This is a specified amount of money which is the maximum amount that the surety will be required to pay in the event of the principal's default. This allows the surety to assess the risk involved in giving the bond; the premium
Premium
Premium may refer to:* Premium , a promotional item that can be received for a small fee when redeeming proofs of purchase that come with or on retail products....

 charged is determined accordingly.

Surety bonds are also used in other situations, for example, to secure the proper performance of fiduciary duties by persons in positions of private or public trust.

Annual US surety bond premiums are approximately $3.5 billion. State insurance commissioner
Insurance commissioner
Insurance commissioner is an executive office in many U.S. states, some in the state cabinet. The office differs state by state:...

s are responsible for regulating corporate surety activities within their jurisdictions. The commissioners also license and regulate brokers or agents who sell the bonds.

History


Individual Surety Bonds are the original form of suretyship. The earliest known record of a contract of suretyship is a Mesopotamian tablet written around 2750 BC. There is evidence of Individual Surety Bonds in the Code of Hammurabi and in Babylon, Persia, Assyria, Rome, Carthage, the ancient Hebrews and later England.

The Code of Hammurabi
Code of Hammurabi
The Code of Hammurabi is a well-preserved Babylonian law code, dating to ca. 1780 BC . It is one of the oldest deciphered writings of significant length in the world. The sixth Babylonian king, Hammurabi, enacted the code, and partial copies exist on a human-sized stone stele and various clay...

, written around 1790 BC, was the first time suretyship was addressed in a written legal code.

It wasn't until 1837 that the first Corporate Surety was organized, The Guarantee Society of London.

In 1865, the Fidelity Insurance Company became the first US Corporate Surety company, but the venture soon failed.

Contract Surety Bonds


Contract bonds, used heavily in the construction
Construction
In the fields of architecture and civil engineering, construction is a process that consists of the building or assembling of infrastructure. Far from being a single activity, large scale construction is a feat of human multitasking...

 industry, are a guarantee from a Surety to a project's owner (Obligee) that a general contractor (Principal) will adhere to the provisions of a contract.

Included in this category are: bid bond
Bid bond
A bid bond is issued as part of a bidding process by the surety to the project owner, to guarantee that the winning bidder will undertake the contract under the terms at which they bid....

s (guarantee that a contractor will enter into a contract if awarded the bid), performance bond
Performance bond
A performance bond is a surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor.A job requiring a payment & performance bond will usually require a bid bond, to bid the job...

s (guarantee that a contractor will perform the work as specified by the contract), payment bonds (guarantee that a contractor will pay for services and materials), and maintenance bonds
Warranty
In business and legal transactions, a warranty is an assurance by one party to the other party that specific facts or conditions are true or will happen; the other party is permitted to rely on that assurance and seek some type of remedy if it is not true or followed.In real estate transactions, a...

 (guarantee that a contractor will provide facility repair and upkeep for a specified period of time). There are also miscellaneous contract bonds that do not fall within the categories above, the most common of which are subdivision
Subdivision (land)
Subdivision is the act of dividing land into pieces that are easier to sell or otherwise develop, usually via a plat. The former single piece as a whole is then known in the United States as a subdivision...

 and supply bonds.

Commercial Surety Bonds


Commercial bonds represent the broad range of bond types that do not fit the classification of contract. They are generally divided into four sub-types: license and permit, court, public official, and miscellaneous.

License and Permit Bonds


License and permit bonds are required by certain federal, state, or municipal governments as prerequisites to receiving a license
License
The verb license or grant licence means to give permission. The noun license or licence refers to that permission as well as to the document recording that permission.A license may be granted by a party to another party as an element of an agreement...

 or permit
Permit
Permit may refer to:*Permit *Various legal licenses:*License*Work permit*Learner's permit*Permit to travel*Construction permit*Home Return Permit*One-way Permit*Permit is the common name for the Trachinotus falcatus, a type of Pompano....

 to engage in certain business activities. These bonds function as a guarantee from a Surety to a government and its constituents (Obligee) that a company (Principal) will comply with an underlying statute
Statute
A statute is a formal written enactment of a legislative authority that governs a state, city, or county. Typically, statutes command or prohibit something, or declare policy. The word is often used to distinguish law made by legislative bodies from case law, decided by courts, and regulations...

, state law
State law
In the United States, state law is the law of each separate U.S. state, as passed by the state legislature and adjudicated by state courts. It exists in parallel, and sometimes in conflict with, United States federal law. These disputes are often resolved by the federal courts.-See also:*List of U.S...

, municipal ordinance, or regulation
Regulation
Regulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...

.

Specific examples include:
  • Contractor’s license bonds, which assure that a contractor (such as a plumber, electrician, or general contractor) complies with local laws relating to his field.
  • Customs bonds, including importer entry bonds, which assure compliance with all relevant laws, as well as payment of import duties
    Duty (economics)
    In economics, a duty is a kind of tax, often associated with customs, a payment due to the revenue of a state, levied by force of law. It is a tax on certain items purchased abroad...

     and tax
    Tax
    To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...

    es.
  • Tax bonds, which assure that a business owner will comply with laws relating to the remittance of sales
    Sales tax
    A sales tax is a tax, usually paid by the consumer at the point of purchase, itemized separately from the base price, for certain goods and services. The tax amount is usually calculated by applying a percentage rate to the taxable price of a sale....

     or other taxes.
  • Reclamation
    Mine reclamation
    Mine reclamation is the process of creating useful landscapes that meet a variety of goals, typically creating productive ecosystems from mined land...

     and environmental protection bonds
  • Broker’s bonds, including Insurance, Mortgage, and Title Agency bonds
  • ERISA (Employee Retirement Income Security Act) bonds
  • Motor vehicle dealer bonds
  • Money transmitter bonds
  • Health spa bonds, which assure that a health spa will comply with local laws relating to their field, as well as refund dues for any prepaid services in the event the spa closes.

Court Bonds


Court bonds are those bonds prescribed by statue and relate to the courts. They are further broken down into judicial bonds and fiduciary bonds. Judicial bonds arise out of litigation and are posted by parties seeking court remedies or defending against legal actions seeking court remedies. Fiduciary, or probate
Probate
Probate is the legal process of administering the estate of a deceased person by resolving all claims and distributing the deceased person's property under the valid will. A probate court decides the validity of a testator's will...

, bonds are filed in probate courts and courts that exercise equitable jurisdiction; they guarantee that persons whom such courts have entrusted with the care of others’ property will perform their specified duties faithfully.

Examples of judicial bonds include appeal
Appeal
An appeal is a petition for review of a case that has been decided by a court of law. The petition is made to a higher court for the purpose of overturning the lower court's decision....

 bonds, supersedeas bond
Supersedeas bond
A supersedeas bond, also known as a defendant's appeal bond, is a type of surety bond that a court requires from an appellant who wants to delay payment of a judgment until the appeal is over....

s, attachment
Attachment (law)
Attachment is a legal process by which a court of law, at the request of a creditor, designates specific property owned by the debtor to be transferred to the creditor, or sold for the benefit of the creditor. A wide variety of legal mechanisms are employed by debtors to prevent the attachment of...

 bonds, replevin
Replevin
In creditors' rights law, replevin, sometimes known as "claim and delivery," is a legal remedy for a person to recover goods unlawfully withheld from his or her possession, by means of a special form of legal process in which a court may require a defendant to return specific goods to the...

 bonds, injunction
Injunction
An injunction is an equitable remedy in the form of a court order that requires a party to do or refrain from doing certain acts. A party that fails to comply with an injunction faces criminal or civil penalties and may have to pay damages or accept sanctions...

 bonds, Mechanic's lien bonds, and bail bonds. Examples of fiduciary bonds include administrator
Administrator of an estate
The Administrator of an estate is a legal term referring to a person appointed by a court to administer the estate of a deceased person who left no will. Where a person dies intestate, i.e., without a will, the court may appoint a person to settle their debts, pay any necessary taxes and funeral...

, guardian
Legal guardian
A legal guardian is a person who has the legal authority to care for the personal and property interests of another person, called a ward. Usually, a person has the status of guardian because the ward is incapable of caring for his or her own interests due to infancy, incapacity, or disability...

, and trustee
Trustee
Trustee is a legal term which, in its broadest sense, can refer to any person who holds property, authority, or a position of trust or responsibility for the benefit of another...

 bonds.

Public Official Bonds


Public official bonds guarantee the honesty and faithful performance of those people who are elected or appointed to positions of public trust. Examples of officials sometimes requiring bonds include: notaries public, treasurers, commissioners, judges, town clerks, law enforcement officers, and Credit Union volunteers.

Miscellaneous Bonds


Miscellaneous bonds are those that do not fit well under the other commercial surety bond classifications. They often support private relationships and unique business needs. Examples of significant miscellaneous bonds include: lost securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

 bonds, hazardous waste removal bonds, credit enhancement financial guarantee bonds, self–insured workers compensation guarantee bonds, and wage and welfare/fringe benefit (Union
Trade union
A trade union, trades union or labor union is an organization of workers that have banded together to achieve common goals such as better working conditions. The trade union, through its leadership, bargains with the employer on behalf of union members and negotiates labour contracts with...

) bonds..

Fidelity Bonds


Fidelity bond
Fidelity bond
A fidelity bond is a form of insurance protection that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees....

s, also known as employee dishonesty coverage, cover theft of an employer's property by its own employees. Though referred to as bonds, fidelity coverage functions as a traditional insurance policy rather than a surety bond.

See also

  • Co-signing
    Co-signing
    The act of co-signing involves a promise to pay another person's debt arising out of contract if that person fails to do so. Many realtors and landlords require a cosigner for college students, people with bad credit or people whose income is less than a certain, low multiple of the amount of rent...

  • Demand guarantee
    Demand guarantee
    In English writings, traditionally the term “guarantee” denotes an accessory or “conditional” type of obligation. The essence of the instrument is the promise to answer for the duty of another should the other default. The beneficiary of such a promise will not be entitled to payment unless it can...

  • Fidelity Bonds
  • Fiduciary
  • Indemnity
    Indemnity
    An indemnity is a sum paid by A to B by way of compensation for a particular loss suffered by B. The indemnitor may or may not be responsible for the loss suffered by the indemnitee...

  • Insurance
    Insurance
    In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

  • Performance Bond
    Performance bond
    A performance bond is a surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor.A job requiring a payment & performance bond will usually require a bid bond, to bid the job...

  • Submittals (construction)
    Submittals (construction)
    Submittals in Construction Management are shop drawings, material data, samples, and product data. Submittals are required primarily for the architect and engineer to verify that the correct products will be installed on the project....

  • Shop drawing
    Shop drawing
    A is a drawing or set of drawings produced by the contractor, supplier, manufacturer, subcontractor, or fabricator. Shop drawings are typically required for pre-fabricated components. Examples of these include: elevators, structural steel, trusses, pre-cast, windows, appliances, cabinets, air...

  • Testator
    Testator
    A testator is a person who has written and executed a last will and testament that is in effect at the time of his/her death. It is any "person who makes a will."-Related terms:...


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