Understanding Surety Bonding

Understanding Surety Bonding - Risk and Responsibility:...

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Risk and Responsibility: Understanding Surety Bonding http://www.sio.org/html/studyguide.html 1 of 8 9/27/2006 12:46 AM Order | Return to Home Page Risk and Responsibility: Understanding Surety Bonding A Study Guide What Are Surety Bonds? Contract surety bonds provide assurance to the project owner that a contractor is capable of completing a project according to contract specifications. Suretyship is a loss-avoidance mechanism to prequalify contracting firms based on their credit strength, experience, and capability to successfully complete contracts. The economic risk of contractor default stays with the bonded contractor, who must sign an indemnity agreement holding the surety harmless. When it issues a surety bond, the surety company has prequalified the contractor and offers assurance to a project owner that the contractor is capable of performing the contract according to its terms and conditions. Furthermore, the surety company guarantees that the contractor will pay certain laborers, subcontractors, and suppliers associated with the project. How Does a Surety Bond Work? Contract surety bonds are three-party agreements whereby one party (the surety company) guarantees another party (the owner) that a third party (the contractor) will perform the contract. The owner specifies the bond requirement in the contract documents. It is the contractor’s responsibility to secure the bonds. Because of the intricacy of the bonding process, and the fact that each surety company has its own unique underwriting standards and practices, contractors turn to surety bond producers to secure the surety bond on their behalf. The contractor includes the cost of the bond premium in his/her bid price. The surety company typically charges only for the final bond(s) when the contractor is awarded the contract. Bonds are required on most public work projects. Most public works contracts are awarded under a competitive, sealed, open competition bidding system where the work is awarded to the lowest responsive bidder. To protect tax-payer dollars from irresponsible bidders and incapable contractors, Congress passed the Heard Act in 1894, which required contractors to obtain surety bonds on public work. The Heard Act was later replaced by the Miller Act of 1935, which mandates performance and payment bonds on all federal public work contracts in excess of $100,000. Most state and local governments have adopted similar legislation (often referred to as "Little Miller Acts"). The requirements stipulated by "Little Miller Acts" vary by state. Types of Contract Surety Bonds The bid bond provides financial assurance that the contractor is capable of performing the contract at the price bid, and will comply with the conditions of the bid, including entering into a final contract if the successful bidder. It also assures the owner that the surety company will issue the requisite payment and performance bonds. If the contractor is awarded the contract but fails to enter into the agreement, the surety may be required to
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Understanding Surety Bonding - Risk and Responsibility:...

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