Bonding

The bonding process is based on a concept called suretyship. Suretyship is different from insurance because it’s a three-party agreement, while most insurance contracts involve two parties.

Suretyship also differs from insurance in how losses are viewed:

• Insurers expect some losses to occur.
• A surety (the provider of a bond) does not expect losses.
• A surety generally won’t issue a bond if a loss is likely.

There are two basic forms of bonds:

• Surety bonds
• Fidelity bonds

Bonding is about guaranteed performance. If one party doesn’t perform as promised, the other party is protected by the surety (the third party).

Surety contracts

A surety contract (a surety bond) is a promise by one party, the surety, to answer for another party’s obligation to a third.

Differences between surety and insurance

	Insurance	Suretyship
Parties	Two: the insurer and the insured	Three: the principal, the obligee and the surety
Losses	Expected; premiums are priced to pay them	Not expected; a bond is issued only when the principal is expected to perform
Who the coverage protects	The insured, who buys the policy	The obligee, although the principal usually buys the bond
After a loss is paid	The insurer has no right to recover from its own insured	The surety may recover from the principal what it paid

Because the surety expects the principal to perform, surety underwriting resembles a credit decision: it examines the principal’s character, ability and financial strength, and usually requires the principal to sign an agreement to indemnify the surety for anything it pays.

Obligation of the surety

The surety guarantees the obligee that the principal will perform the obligation the bond describes, such as completing a construction contract or faithfully carrying out a public office. If the principal defaults, the surety must either see that the obligation is performed or pay the obligee, up to the amount of the bond (its penal sum). The surety’s obligation is secondary: it arises only when the principal fails to perform. Having paid, the surety has the right to recover the payment from the principal.

Parties to the surety bond

A bonding agreement involves three parties:

• Principal: the party whose performance is being guaranteed.
• Obligee: the party protected by the bond.
• Surety: the third party that provides the financial guarantee.

Once purchased, surety bonds remain in effect until they’re canceled or until the required performance is completed according to the bond’s terms.

If a bond pays damages to the obligee, the surety has the right to recover from the principal any amounts paid, according to the terms of the bond.

Fidelity bonds

Fidelity bonds protect employers from employees who act dishonestly. For example, a business might purchase a fidelity bond for employees who handle and disburse cash.

Fidelity coverage may be secured by an employer by purchasing:

• An individual bond identifying a specific employee
• A schedule bond naming several employees
• A bond naming employment positions (i.e., officers and directors)
• A blanket bond that covers all employees with no specific names or employment positions designated

Surety Bonds

A surety bond is different than a fidelity bond. A fidelity bond guarantees that an employee will not commit certain dishonest acts. A surety bond guarantees that certain acts will happen - that someone will faithfully perform the act they agreed to perform.

Surety bonds may be categorized in several ways, including:

• Contract bonds
• Judicial bonds
• License and permit bonds
• Public official bonds

Contract Bonds guarantee the performance of a principal to complete work according to the contract with an obligee.

For example, assume the obligee is the City of Phoenix, and the principal is Behunin Construction Company. Behunin and the City of Phoenix have entered into an agreement that Behunin will complete the construction of a causeway. The City of Phoenix wants protection in case Behunin does not complete the work. Therefore, as a condition of receiving the contract, Behunin must purchase a contract bond to guarantee its performance according to the agreement.

Judicial Bonds include court bonds and fiduciary bonds. These bonds guarantee that an individual or organization satisfies his, her or its obligations while acting in a position requiring trust and confidence. They fall into two general categories, Fiduciary and Litigation bonds.

Bail bonds are a type of litigation bond issued in connection with a court case.

Examples of Fiduciary bonds include:

Executors

• Executes the provisions of a will.

Administrators

• Appointed by the court when a person dies and does not leave a will with an appointed executor.

Guardians

• When parents are deceased, a person is usually appointed by the court to care for and manage the minors and the estate.

Litigation bonds (sometimes called Financial Guarantee bonds or Court bonds) are often difficult to place with a carrier because of the high risk. Examples include:

Appeal Bonds

• When one loses in court and is made to pay damages, he can post an appeal bond and postpone payment pending his appeal.

Attachment Bonds

• Prior to taking one’s property, which is the subject of litigation, the person taking the property must post this type of bond.

Injunction Bonds

• Posted with the court to stop some action or activity. Designed to pay damages if the person or business has been wrongfully affected.

Bail Bonds

• A bond that guarantees the appearance of a defendant in court.

Lesson Summary

Suretyship is the foundation of bonding. It differs from insurance because it involves three parties rather than two.

• Insurers expect losses in insurance contracts, while a surety (bond provider) does not expect losses.
• A surety will not issue a bond if losses are likely.

There are two main types of bonds:

• Surety bonds
• Fidelity bonds

Bonding ensures guaranteed performance. If one party fails to perform, the other party is protected by the surety, the third party involved.

The three parties in a bonding agreement are:

• Principal: Whose performance is guaranteed
• Obligee: Protected by the bond
• Surety: Provides financial guarantee

Surety bonds stay effective until canceled or until performance is completed as per the bond terms. When a bond pays damages to the obligee, the surety can recover from the principal as per the bond terms.

Fidelity Bonds:

• Protect employers from dishonest acts by employees handling money
• Can be individual, schedule, employment position, or blanket bonds

Surety Bonds:

• Differ from fidelity bonds by guaranteeing faithful performance of agreed-upon acts
• Categories of surety bonds include contract, judicial, license and permit, and public official bonds

Contract Bonds:

• Guarantee a principal’s performance as per a contract with an obligee
• An example is Behunin Construction Company ensuring the completion of work for the City of Phoenix

Judicial Bonds:

• Include Fiduciary and Litigation bonds
• Fiduciary bonds (also called probate bonds) involve Executors, Administrators, Guardians
• Litigation bonds encompass Appeal, Attachment, Injunction, and Bail bonds

Chapter Vocabulary

Definitions

Blanket Bond

A bond that covers all employees. A type of fidelity bond.

Bond

A form of suretyship. Bonds of various types guarantee a payment or a reimbursement for financial losses resulting from dishonesty, failure to perform, and other acts.

Fidelity Bond

A bond covering an employer’s loss resulting from an employee’s dishonest act (e.g., loss of cash, securities, valuables, etc.).

Fiduciary

A person holding the funds or property of another in a position of trust and who is obligated to act in a prudent and ethical manner. Examples are attorney, bank trustee, or executor of an estate.

Fiduciary Bond

A type of surety bond, sometimes called a probate bond, which is required of certain fiduciaries, such as executors and trustees, that guarantees the performance of their responsibilities.

Financial Guaranty

A surety bond, insurance policy, or indemnity contract (when issued by an insurer), or similar guaranty types under which loss is payable upon proof of occurrence of financial loss to an insured claimant, obligee, or indemnitee as a result of failure to perform a financial obligation or any other permissible product that is defined as or determined to be financial guaranty insurance.

Obligee

The party reimbursed by the surety if the principal fails to perform.

Principal

In bonding, the party has a duty to perform.

Schedule Bond

A type of Fidelity Bond. The bond is available by a name schedule, which lists a number of persons by name, or a position schedule, which lists the positions to be bonded and the number of people in each position.

Surety

The company issuing a bond. Guarantees the performance of the principal.

Surety Bond

Guarantees the performance of a duty. It obligates the surety to hold itself responsible for the performance of a duty by the principal. Includes contract bonds, judicial bonds, public office bonds, and license and permit bonds.