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A surety bond is a contract among at least three
parties:
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The principal - the primary party who will be
performing a contractual obligation
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The obligee - the party who is the recipient of
the obligation, and
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The surety - who ensures that the principal's
obligations will be performed.
Through this agreement, 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.
There are two main categories of bond types: contract bonds and commercial
bonds. Contract bonds guarantee a specific contract. Examples include
performance, bid, supply, maintenance and subdivision bonds. Commercial
bonds guarantee per the terms of the bond form. Examples include license &
permit, union bonds, etc.
Suretyship bonds originated hundreds of years ago as a mechanism through
which trade over long distance could be encouraged. The first corporate
surety firm in the United States was United States Fidelity and Casualty
Company of New York, established in 1880. According to the Surety & Fidelity
Association of America annual US surety bond premiums are approximately $3.5
billion. State insurance commissioners are responsible for regulating
corporate surety activities within their jurisdictions. The commissioners
also license and regulate brokers or agents who sell the bonds.
Surety bonds are frequently used in the construction industry: in order to
obtain a contract to build the project, the general contractor (and often
the sub-contractors as well) must provide the owner a bond for its
performance of the terms of the contract. Conversely, owners and contractors
may also provide payment bonds to ensure that subcontractors and suppliers
are paid for work done. Under the Miller Act, payment and performance bonds
are required for general contractors on all U.S. federal government
construction projects where the contract price exceeds $100,000.00.
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.
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 charged is
determined accordingly.
If the principal defaults and the surety turns out to be insolvent, 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.
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.
A bail bond is a type of surety bond used to secure the release from custody
of a person charged with a criminal offense. Under such a contract, the
principal is the accused, the obligee is the government, and the surety is
the bail bondsman.
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