What is a Surety Bond?

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Many contractors have asked us what is a surety bond. Please read this page for a detailed explanation. Or if you'd prefer a quick and concise explanation, please follow this link "What is a surety bond?".

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What is a Surety Bond?

If the second party (the principal) fails to meet its obligations to the third party (the obligee), the first party (the surety) is duty bound to fulfill those obligations.

Example:

Ajax Bonding Company (the surety) issues a surety bond guaranteeing that John Doe Paving (the principal) will fulfill its contract with Gotham City (the obligee) to build a road, and it will do so within a certain time-frame and cost.

If John Doe Paving doesn't fulfill its contract with Gotham City to build the road, Ajax Bonding (who at this point becomes the principal in addition to being the surety) will have to contract with another contractor, say ABC Paving Company, to build the road at whatever price ABC Paving and Ajax Bonding agree to.

Ajax Bonding will complete the project using ABC Paving. When the project is complete and approved by Gotham City, Ajax will receive, from Gotham City, whatever monies are still owed on the original contract between Gotham City and John Doe Paving.  John Doe Paving will owe to Ajax whatever costs Ajax incurred over and above what Gotham City has paid them.  Ajax may have to sue John Doe Paving to recover those costs.

What is a Surety Bond? There are 3 common types of surety bonds:

Examples:

a) Bid bonds - A "Bid Bond" means that the surety (Ajax Bonding) guarantees John Doe Paving (the contractor and principal) will enter a contract and will provide a performance bond if awarded the job.

If John Doe Paving wins the bid and is awarded the project then Ajax Bonding will supply John Doe Paving with a performance bond for the bid amount. The bid bond is usually 10% of the bid amount.

If John Doe Paving does not win the bid and is not awarded the contract, Ajax Bonding's guarantee is null and void.

However, if John Doe Paving DOES win the bid but for whatever reason refuses to accept the award and refuses to enter into a contract for any of a number of reasons:

• maybe he's too busy, or

• maybe his license has been suspended, or

• maybe he reviewed his bid and realized that he screwed up and should have bid $100,000 higher than he did, etc.

then the obligee awards the contract to another contractor and Ajax Bonding (John Doe's surety) may be required to pay (forfeit) the 10% bid bond amount to the obligee.

Should this happen, Ajax Bonding will in turn sue John Doe Paving to recover its losses.

b) Payment bonds - A "Payment Bond" guarantees that the surety will pay the bills of the suppliers and subcontractors if the contractor (the principal) fails to do so.

If John Doe Paving (the principal) does not pay his bills to his suppliers and subcontractors, Ajax (the surety) must step forward and pay them, and will most likely sue John Doe Paving to recover its losses.

c) Performance Bonds - A "Performance Bond" is a written guarantee by a Surety that the terms of a contract will be fulfilled.

If the contractor (the principal) fails to perform the terms of a bonded contract, Ajax Bonding (the surety) becomes the principal and hires another contractor (ABC Paving) to complete the project (and all contract terms), at whatever the cost.

When the project is complete and approved by Gotham City, Ajax will receive, from Gotham City, whatever monies are still owed on the original contract between Gotham City and John Doe Paving.  

John Doe Paving will owe to Ajax whatever costs Ajax incurred over and above what Gotham City has paid them.  Ajax may have to sue John Doe Paving to recover those costs.

d) Maintenance bonds - A "Maintenance Bond" provides that the surety guarantees that the contractor (the principal) will provide repair and upkeep for a specified period of time as required by the contract.

If John Doe Paving (the contractor and principal) does not comply with the repair and upkeep terms of the contract for the specified period of time, Ajax Bonding (the surety) will hire another contractor to provide the repair and upkeep and will pay that contractor for his work. Then Ajax (the surety) will sue John Doe Paving to recover its lost costs on the deal.

If the business (the principal) does not adhere to its public trust (fails to pay suppliers, defrauds the public, etc.) a claim may be brought against the business and the surety may be forced to pay up to the limit of the bond. If this happens, the business (the principal) is required to repay the surety for its loss.


3. Bail bonds - A "Bail Bond" is used to secure the release from custody of a person charged with a criminal offense. The principal is the accused, the obligee is the government, and the surety is the bail bondsman. If the accused fails to appear, a fugitive recovery agent is hired by the bondsman and thus becomes the surety for the court.

Sidenote: Because this article, "What is a Surety Bond", is written primarily for construction contractors, we won't worry about addressing Bail Bonds any further than as explained above.

Thank you and hopefully we've answered your question of What is a Surety Bond?

But if you still have questions about surety bonds and what they are/do, please contact us for more information and/or to get a quote for a surety bond and/or construction insurance.

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