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Summary of Surety Principles

Summary of Surety Principles

The following elements are common to all surety transactions:

All surety bonds have three parties. The principal/obligor/contractor performs the work. The surety guarantees the work. The obligee/owner is the entity that expects that the work will be completed successfully and according to contract terms. The principal and surety are discharged from further liability after the work is completed. The principal that defaults or fails to perform triggers a demand from the obligee to pay some, if not all, of the bond amount penalty. This penalty is also called a penal sum.

Example: The contractor is J & J Construction, the owner is Kerry County Developers, and the surety is ABC Surety Company. Kerry County Developers is developing a shopping center. If J & J does not perform its obligations properly, ABC Surety is obligated to Kerry County Developers for the bond amount.

Principal/contractor and surety are jointly and severally liable to the obligee/owner. If the principal/contractor fails to perform, the surety must fulfill the obligation in place of the principal/contractor.

Example: J & J Construction declares bankruptcy and cannot complete the shopping center. ABC Surety is liable to Kerry County Developers for the bond amount.

Except for most license and permit bonds, the surety does not have the option of canceling its obligation before the principal completes the project.

Example: ABC Surety realizes that the J & J Construction has financial problems but it cannot cancel the bond.

A surety can reduce its exposure by requiring support of personal, partnership, or corporate indemnity on behalf of the principal. In this way, the surety can look to the indemnitors if the principal defaults.

Note: A word of caution is in order here. It is often said that indemnity is a good crutch to lean on, but not to lean on it too heavily. Like a bank guarantor, a surety indemnitor is not jointly and severally liable with the principal/borrower. The surety/bank must make every effort to fully recover its loss from the principal/borrower. Any recovery should include application of credits, salvage in surety cases, unearned interest on bank loans, and collateral (if any) before a demand can be made on the indemnitor/guarantor to recover any remaining loss.

Example: ABC Surety first looks to J & J Construction for restitution but then looks to Mark Johnson and Jerry Johnson personally because they are surety indemnitors.

Once the surety sustains a loss on behalf of a defaulting principal, the obligee’s rights of recovery against the principal are subrogated to the surety. The same rights pass to loan guarantors against the makers or borrowers once they have to make good on a loan default.

Example: Once ABC Surety pays Kerry County Developers, ABC Surety takes over Kerry County Developers’ rights to pursue J & J Construction.

If you have questions or need help securing a Surety Bond call us at 800-392-6532.

Business Insurance for Contractors in the Lake Sunapee, and Upper Valley of New Hampshire and Vermont. 
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