The way project owners evaluate and manage risks on construction projects and make fiscally responsible decisions to ensure timely project completion are crucial to their success. Since private owners cannot afford to gamble on a contractor whose reliability is uncertain or who could end up bankrupt halfway through the job, a surety bond serves as a critical safety net for the investment.
What is Suretyship?
Suretyship is a specialized line of insurance created when one party guarantees the performance of an obligation by another party. A surety bond is a written agreement involving three parties:
- The principal: The party undertaking the obligation.
- The surety company: The entity guaranteeing that the obligation will be performed.
- The obligee: The party benefiting from the bond.
Types of Surety Bonds
There are two main categories of surety bonds: contract (or corporate) surety bonds and commercial surety bonds.
Contract (or Corporate) Surety Bonds
Contract surety bonds provide financial security and assurance for construction projects, ensuring that the project owner (obligee) receives quality work from the contractor (principal). These include:
- Bid bonds: Assure that bids are submitted in good faith.
- Performance bonds: Protect the owner from financial loss if the contractor fails to meet the contract terms.
- Payment bonds: Guarantee that subcontractors, laborers, and suppliers are paid.
- Maintenance bonds: Cover defective workmanship or materials for a set period.
- Subdivision bonds: Ensure the completion of public infrastructure improvements such as roads and sewers.
Commercial Surety Bonds
Commercial surety bonds guarantee that the principal will fulfill the specified obligation. Examples include:
- License and permit bonds: Required by state or local authorities for businesses such as contractors and motor vehicle dealers.
- Judicial and probate bonds: Ensure fiduciaries comply with court orders.
- Public official bonds: Guarantee that public officials fulfill their duties.
- Federal bonds: Required by the federal government, such as those for Medicare providers.
- Miscellaneous bonds: Cover lease agreements, lost securities, and union contributions.
Suretyship vs. Traditional Insurance
While suretyship and traditional insurance share some similarities, such as regulation by state insurance commissioners, there are key differences:
- In traditional insurance, risk is transferred to the insurer, whereas in suretyship, the risk remains with the principal, protecting the obligee.
- Insurance companies expect to pay claims, while surety premiums are service fees for financial backing and guarantees.
- Insurance underwriting aims to spread risk, while surety underwriting focuses on pre-qualification and creditworthiness.
Government Regulations on Surety Bonds
The Miller Act requires performance and payment bonds for federal public work contracts exceeding $100,000. Additionally, most U.S. states and local jurisdictions enforce similar bonding requirements for public projects.
Protect Yourself With Surety Bonds
By securing a surety bond, you mitigate risks related to project completion and quality. Contact our expert team today to learn more about protecting your business.