Commercial and contract surety bonds: an important asset to all parties involved.

• Author: Barbour, Tracy
• Position: INSURANCE

Surety bonds are increasingly becoming an essential asset for businesses and professionals who are seeking to land contracts for public and private projects.

A surety bond is a three-party agreement designed to ensure an individual will perform according to the terms of a contract. More specifically, it represents a promise by a surety (or guarantor) to pay one party (the obligee, who is typically a project owner) a certain amount of money if a second party (the principal, who is typically the contractor or builder of the project) fails to meet an obligation. "The agreement includes an indemnity agreement between the principal and the surety company," says Jack Grieco, a senior account executive with Alaska USA Insurance Brokers.

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In its basic form, surety bonding is similar to insurance in that it is a method of transferring or managing risk, Grieco says. Bonding activities are regulated by State Insurance Commissioners. Companies that offer bonds are typically insurance companies, and the state requires that bonds be placed by a licensed property and casualty insurance broker. However, unlike with insurance--which is designed to compensate the insured against unforeseen adverse events--surety is designed to prevent a loss.

A surety bond is also a credit-based financial instrument. And according to Grieco, a surety company is only interested in issuing a promise for a principal if the principal meets a certain set of criteria. The criteria can include a good credit rating, adequate working capital, a proven track record in completing similar contracts or jobs, and good "character" on the part of the firm and its owners. "It is important to the surety company that the principal has good financial strength because the bond is not insurance; it is a promise," he says. "The promise is that the surety company will pay to complete the project for the obligee if the principal cannot complete the project. The principal promises to repay the surety for any payments made to complete the project."

Types of Surety Bonds

There are generally two kinds of surety bonds: contract and commercial. Contract bonds, commonly called construction bonds, include bid, performance, and payment bonds. In terms of their purpose, a bid bond assures that the bid is submitted in good faith and that the contractor will enter into the contract at the price specified. A performance bond promises the owner that the contractor is capable and qualified to perform the contract. A payment bond guarantees the contractor will pay specified subcontractors, laborers, and suppliers associated with the project.

Commercial...