What You Need to Know About Surety Bonds

Commercial surety bonds guarantee that a business or individual complies with the security requirements of federal and/or provincial courts, government bodies, financial institutions, and private corporations. They protect against financial risks such as fraud, misrepresentation and compensation of monetary loss. Surety bonds can only be issued by companies licensed by the federal government or provincial regulatory body. These companies must demonstrate the financial solvency and sufficient strength to meet potential claims obligations.

What is a surety bond?

A surety bond is a three-way agreement between the principal, obligee and the surety. The importer is the principal, the government agency (CBSA) is the obligee and the bond is provided by the surety company.

Obligee: The entity that requires the bond, often a government agency in charge of regulating or licensing an industry.

Principal: The individual or business required by the obligee to obtain a bond.

Surety: The insurance company that writes and financially backs the surety bond.

How does a surety bond work?

A surety bond requires the surety to pay a set amount of money to the obligee if a principal/importer fails to perform the contractual obligation.

What is an indemnity agreement for surety?

A surety bond indemnity agreement is a signed agreement between the principal and the surety that states the principal will œindemnify the surety company should a claim occur. Indemnification is the process of repaying the surety company, bringing them back to where they started.

What is the purpose of an indemnity agreement?

When the term indemnity is used in the legal sense, it may also refer to an exemption from liability for damages. Indemnity is a contractual agreement between two parties. In this arrangement, one party agrees to pay for potential losses or damages caused by another party.

What does indemnity mean in legal terms?

An indemnity is a promise by one party to compensate another for the loss suffered because of a specific event, called the œtrigger event. The trigger event can be anything defined by the parties, including a breach of contract, a party's fault or negligence, or a specific action.

What is surety underwriting?

Surety underwriting is a process performed by a qualified expert, known as an underwriter, to determine if a bond can be issued and how much an applicant will pay for their bond. Surety underwriters examine the bond application and the applicant's financial history to determine the level of risk the surety company is taking in writing a bond.

Why do surety companies underwrite bonds?

The surety underwriting process is used when a bond is deemed risky by the surety company. Risk is the possibility of financial loss due to the potential negligent or damaging actions on the part of the principal. This classification of œrisky often stems from the history of claims against the bond.

What do surety companies take into consideration when underwriting?

Aside from a bond claim history outlined above, a surety underwriter will carefully review the applicant's qualifications. The underwriter is looking to establish the applicant's character, capacity and capital during the underwriting process. Honesty and integrity are the underwriter's focus when determining an applicant's character. Possessing set moral principles and a determination to meet obligations proves to the underwriter that an applicant is of strong character.

For example, an applicant knowingly providing false information on a bond application would bring their character into question. Capacity refers to whether an applicant has the proper experience and can execute, with regards to financial limitations, on that knowledge. This is where an underwriter will look at an applicant's expertise, education, industry stability, credit history, personnel, and any machinery or facilities owned. An applicant must be able to deliver on the guidelines of their bond and occupational work.

Capital examines the bond amount and conditions of the bond during underwriting. The higher the bond amount, the riskier it is to write. Bonds that are required for multiple years are also considered higher risk.

Another step in the underwriting process is to determine the terms and conditions that affect either the principal's performance or the nature of the surety's guarantee. These conditions and terms may be found in either the bond form or by reading the statutes referenced in the bond form or licensing laws.

How does the applicant's information affect the bond quote?

While underwritten bonds may be riskier for surety companies to write, qualified applicants are typically quoted at 1% to 3% of the bond amount. However, an applicant's personal information and history can have adverse effects when taken into consideration by the underwriter - the bond could be denied, or the premium could be higher than expected.

An underwriter is more likely to deny an application if the applicant has a current or previous bankruptcy, lawsuit or lien. If the applicant has a history of not paying or falling behind on payments, such as loan payments, an underwriter may also be less likely to provide a bond quote. However, an underwriter may decide that falling behind on a loan payment does not warrant denial. Instead, the applicant may receive a quote, but the premium could be higher to account for the greater risk of approving an applicant with a history of late payments.

A premium increase is also common for applicants with poor credit, a risky type of bond or those looking to obtain a large bond amount. While all these factors may be taken into consideration by an underwriter, it is ultimately up to the training and expertise of underwriters to determine if the bond can be written and at what premium. Because no two applicants have the same information, bond quotes are expected to have varying premiums.

Surety bonds vs. insurance

Unlike an insurance policy, in which there are two parties to the agreement - the insurer and the insured - a surety bond is a three-party agreement consisting of the principal, the obligee and the surety company. It is important to understand a surety bond is not insurance. It is a guarantee that the principal will perform the obligations detailed in the bond form and in any other documents incorporated by reference, such as a statute or a construction contract.

Failure to completely perform all the obligations guaranteed by the bond could result in a claim being made by the bond obligee for default. In the event a claim is filed on the bond, the surety will begin an investigation. It is important to understand that the principal is legally obligated to reimburse (indemnify) the surety for all losses incurred by the surety under the bond, including expenses like attorney fees. Before signing the bond, the principal should fully understand and be comfortable with the reimbursement risk, as well as with all the other obligations covered by the bond.

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