Definitions of Surety Terms
WHAT'S A BOND?
While there are many different types of bonds, they all share the same definition in what they do.
A surety bond is a promise by one party to be liable for the debt, default, or failure of another party. For example, in a contract surety bond obligation, the surety bond is a three-party agreement in which one party (the surety) guarantees or promises a second party (the obligee) that a third party (the principal) will successfully perform a contract.
The surety is a financial institution, such as an insurance or surety company. The surety extends its promise and assets to the obligee on behalf of the principal should the principal not perform per the contract. The obligee is the protected party receiving the promise. In construction, the obligee is the job owner. The principal is the party who must perform the promise. In construction, the principal is the contractor performing the work under the contract.
A bond should never be confused with insurance. Insurance contemplates losses. They are expected. In surety, losses are not contemplated. If all parties to the three-party surety agreement perform as they should, there should be no losses.
One final difference between insurance and surety is the actual obligations of the principals. Insurance is a deal to transfer risk of expected losses in exchange for a fixed premium. The premium for bonds is only intended to rent the financial standing of the surety, not to pay losses. Insurance carriers have no recourse. Sureties do have recourse.
In surety, the principal promises to repay the surety if the principal fails to perform the contract and the surety suffers a loss (due to the surety's promise to the obligee). This relationship and responsibility is outlined in an indemnity agreement that the principal must sign prior to the surety releasing any bonds to obligees on behalf of the principal. This contractual obligation states that the principal is liable for all losses, costs, and attorneys fees resulting from the principal's default under the contract with the obligee.
TYPES OF BONDS:
A bid bond guarantees that the bidder (principal) will actually enter into the contract at the bid price stated and will provide the required performance and payment bonds to the owner (obligee).
While called bonds, these obligations to protect an employer from employee-dishonesty losses are really insurance policies. These insurance policies protect from losses of company monies, securities, and other property from employees who have a manifest intent to cause the company loss. There are also many other forms of crime-insurance policies (burglary, fire, general theft, computer theft, disappearance, fraud, forgery, etc.) to protect company assets.
As with fidelity bonds outlined above, Financial-Institution Bonds are technically insurance policies. They protect against loss of bank assets and depositor assets (as a commercial crime-policy does). The only difference is that the insured is a financial institution with much more currency-loss exposure than a standard commercial business.
These obligations are classified as bonds but are really insurance policies. These policies protect employee-benefit trustees from personal loss due to their error, omission, or wrongful act as it regards management of an employee-benefit plan of any kind.
Bonds in judicial proceedings are filed by parties engaged in litigation to procure the benefits of relief afforded by law, such as Replevin, Attachments, Garnishments, etc. These bonds guarantee to the opposing party payment of the opposing party's costs and damages in the event the Court's judgment is in favor of that opposing party.
License and Permit bonds take on may shapes and sizes. Most of these obligations are brought about by a statute of some kind for the protection of the general public. An example is the Commercial Contractor's License bond in The State of Arizona, USA. In this bond, the principal (contractor) promises to build all buildings in accordance to statutory building codes. The obligee is The State of Arizona and the people in the state who may contract for the contractor's services.
The payment bond protects most providers of material and labor to a job. It guarantees that the contractor will pay bills in accordance with the contract terms.
A performance bond protects the owner (obligee) from financial loss caused by the contractor (principal) who fails to build the project in accordance with the terms, specifications, and conditions of the contract for construction.
Probate bonds, or bonds filed in a probate court, apply to all types of bonds required of persons appointed to positions of trust by the court, such as Guardians, Executors, Administrators, Receivers, etc. These bonds guarantee the faithful performance of duties and an equitable accounting for property received and distributed.
These bonds arise when an employer decides to self-insure a large portion of potential workmen's compensation exposure. The bond guarantees that the employer (principal) will pay workmen's compensation benefits to any worker injured during the time period in which the bond is in force.