Gallagher McIntyre

Surety

Overview

A surety bond is a contract among at least three parties:

  • The principal – the primary party who will be performing the work or fulfilling the contractual obligation, usually a contractor or subcontractor.
  • The obligee – the party requiring the contract be completed. This is typically the project owner or customer for whom the work is being done or the construction manager.
  • The surety – the company making the guarantee on behalf of the principal. Typically this is an insurance company writing the bond.
  • The principal – the primary party who will be performing the work.

A surety bond is a promise to pay one party (the obligee/usually the owner) a certain amount if a second party (the principal/often a contractor) fails to meet some obligation, such as fulfilling the terms of a contract. The surety bond protects the obligee against losses resulting from the principal’s failure to meet the obligation.

Through a surety bond, the surety agrees to maintain the contractual promises (obligations) made by the principal if the principal fails to perform or pay the contractual promises they have made to the obligee.

To provide a bond, a surety company thoroughly underwrites the financial strength and ability of the principal to meet their promises as outlined in the contract specification. This includes, but is not limited to: a detailed analysis of the principal’s financial condition, past performance on similar projects, work in process, professional ability of personnel to complete the project in accordance with the contract specifications and timeline, credit history, banking relationships, personal financial strength of the owners of the principal’s business, and a viable business succession plan.

Depending on the amount of bond activity, a surety company may extend a bond line to the principal. A bond line provides the principal with a per project, aggregate amount of credit the surety is willing to extend for specific types of projects. Projects outside the normal scope of operations and expertise of the principal typically are separately underwritten.

Once approved by the surety a project is then bid, and if won, the principal will pay a premium in exchange for the surety company’s financial strength to extend surety credit. The amount of credit supplied on a bond is known as the penal sum. This is a specified amount of money that 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 providing the bond.

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