Summary of Surety Principles

All surety bonds have three parties. The principal/obligor that performs the work and the surety that guarantees the work assure the obligee, or the owner in contract surety, that the obligation the principal assumes will be completed successfully and according to contract terms. After the work is completed, the principal and surety are discharged from further liability. Default or failure to perform often triggers a demand for payment of some, if not all, of the bond amount, penalty or penal sum.

Example: The principal is J & J Construction, the obligee is Kerry County Developers and the surety is ABC Surety Company. The project is developing a shopping center. If J & J does not perform its obligations properly, ABC Surety is obligated to Kerry County for the bond amount.

Principal and surety are jointly and severally liable to the obligee. If the principal fails to perform, the surety must fulfill the obligation in place of the principal.

Example: J & J Construction declares bankruptcy and cannot complete the shopping center. ABC Surety is liable to Kerry County Developers for the bond amount

Except for most license and permit bonds, the surety does not have the option of canceling its obligation before the principal completes the project.

Example: ABC Surety realizes that the J & J Construction has financial problems but it cannot cancel the bond.

A surety can reduce its exposure by requiring support of personal, partnership or corporate indemnity on behalf of the principal. In this way, the surety can look to the indemnitors if the principal defaults.

Note: A word of caution is in order. It is often said that indemnity is a good crutch to lean on, but not too heavily. Like a bank guarantor, a surety indemnitor is not jointly and severally liable with the principal/borrower. The surety/bank must make every effort to fully recover its loss from the principal/borrower. Any recovery should include application of credits, salvage in surety cases, unearned interest on bank loans and collateral, if any, before a demand can be made on the indemnitor/guarantor to recover any remaining loss.

Example: ABC Surety first looks to J & J Construction for restitution but then looks to Mark Johnson and Jerry Johnson personally since they are surety indemnitors.

Once the surety sustains a loss on behalf of a defaulting principal, the obligee’s rights of recovery against the principal and surety are subrogated to the surety. The same rights would pass to loan guarantors against the makers or borrowers once they had to make good on a loan default.

Example: Once ABC Surety pays Kerry County Developers, ABC Surety takes over Kerry County Developers’ rights to pursue J & J Construction.

Surety Premiums VS Insurance Premiums

The law of large numbers is the rule applied to most primary insurance lines of coverage. This rule presumes that sufficient premium is collected from all policyholders to cover the losses of the few. Pooling premiums to respond to injury or damage sustained by certain members of that pool is how insurance works

While surety bonds and insurance policies are similar in some respects, there are some very distinct differences. Besides having different contract language, the forms vary in the coverage they provide. Please refer to this Section, Comparison: Surety Versus Insurance, for more information on some of the more important differences.

Surety Bond Underwriter Checklist

  • Financial Information

  • Line of Credit

  • Strategic Business Plan

  • Work History

  • Current Work Schedule

  • Current Surety Program

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