|
WHAT
IS BONDING? (SURETYSHIP)
Throughout history society has observed
that persons or firms do not always honor their obligations as they
have promised to do. Consequently, a system called suretyship has
been developed whereby, in some instances, an outsider ( a surety
) is required to back up the promise of a promisor. Then, if the
promisor (the principal) fails to keep his promise (his obligation),
the surety can be required to pay the damages caused to the promisee
(the obligee)
As you can see surety ship is a very important "credit device"
created by society to aid the conduct of commerce, society, etc.
HISTORY
OF BONDING
Suretyship has been practiced since
very early times. It is mentioned frequently in Bible and early
literature. Originally, sureties were individuals only, as corporations
had not yet come into existence. But once corporations began, sureteyship
underwent some changes that are still evident today. For example,
sureties originally were relatives or friends who lent their guarantee
free. Consequently, early decisions showed leniency to the gratuitous
personal surety. But today, the "paid" corporate surety
is held strictly accountable for their principal's failure.
In early times other faults were observed with personal suretyship.
Their financial strength was often exaggerated. Or, if it existed,
it was dissipated by the time the obligee made his claim. Moreover,
personal suretyship could be complicated by the death of the personal
surety. But, corporations have unlimited life and can better take
on guarantees --especially long term ones.
After corporate sureties came into existence, obligees tended to
favor them over personal sureties for still another reason. That
is, the obligee felt less conscience-stricken on collecting from
the impersonal corporation than he did from the personal surety
--especially if the personal surety was a relative, friend, etc.
For these and various other reasons corporate suretyship has largely
replaced personal suretyship, although personal suretyship is still
possible and is practiced in many states. Corporate suretyship
began in England about 1720 and in the United States about 1875.
KEY
TERMS USED IN BONDING
1) Principal
means the person or firm we are guaranteeing. Some call the principal
the obligator. It means the same.
2)
Obligation
means the "agreement" we are guaranteeing.
3)
Obligee means the legal entity to whom the principal
owes his obligation.
4)
Surety means the carrier who "stands behind"
the principal and who must respond when the principal fails to perform
his obligation.
SURETYSHIP
COMPARED TO INSURANCE
The details of this system are called
the Principles of Suretyship. Now, since insurance companies are
in the business of accepting various kinds of "risks"
and since they have funds available, they (the insurance companies)
do most of the surety business. This has caused endless confusion
in the minds of the public and insurance agents, for the Principles
of Suretyship are not the same as the Principals of Insurance. The
surety business is not a "risk" business. When we insure
a person's building or car, it is expected that we will pay for
the loss, out of our premiums ---even if the insured was careless
in causing the loss --- and without the policy holder reimbursing
us for a loss. Our premium includes an amount calculated to cover
expected losses. But, this is not so with bonds. In writing bonds
we are simply "lending" our credit and financial strength
for a service charge (the bond premium). Except for Fidelity bonds,
the premium is not loaded to cover losses.
In fact, if our bond principal refuses to perform, we are entitled
to take legal action for exoneration, to force him to perform. Or,
if he fails to perform and the obligee gets another to do so and
then collects from us -- we are entitled to subrogate our loss against
our principal. And, if our principal fails to perform and we do
so for him, we are entitled to reimbursement from our principal
for our loss. This possibility of exoneration, subrogation, or reimbursement
is why bonds must be underwritten with great care and skill. And,
why they must be limited to principals who are capable, trustworthy,
and financially responsible. If they have these superior characteristics
they are most likely to properly perform their obligations. But,
should they fail to do so we would still have a good chance of recovering
our loss.
But, since corporate Fidelity and Surety bonds are handled by insurance
companies and insurance agents, we will continually compare suretyship
to your knowledge of insurance policies. But, don't forget that
bonds and insurance policies are different.
Here
are some more difference between bonds and insurance:
1)
SIGNATURES:
Surety bonds must bear the actual signature of the principal and
attorney-in-fact who sign off the surety. This is not so with insurance
policies.
2)
INDEMNITORS OR COLLATERAL:
Sometimes we require that someone else furnish additional indemnity
besides that of the principal. Or, the principal may be required
to post collateral equal to the penalty of the bond. Neither ever
occurs with insurance.
3)
PENALTY:
The amount we are "guaranteeing" in a bond is called the
"penalty", whereas in insurance we usually use the word
"limits". Oftentimes, the amount of this penalty may not
even show on the bond, as with a Bid bond.
4)
INCEPTION AND EXPIRATION DATES:
The time a bond runs is called "the term". The inception
date is the date that the contractual obligation began rather than
the bond issuance date. Most bonds run indefinitely or until the
contractual obligations are fully satisfied or completed.
5)
RENEWALS:
Bonds themselves are not usually renewed. The rates are usually
for one year and if the contractual obligation has not been
fulfilled we charge an additional premium at each succeeding anniversary
date. In most cases, a premium notice is sent out but not a new
bond.
6)
CANCELLATION:
Most bonds, other than Fidelity bonds on employees, cannot be cancelled
-- even if the surety made a mistake in covering the obligations
of an unsatisfactory principal, or undertook a more serious obligation
then they intended to cover.
7)
PREMIUMS AND FORMS USED:
Bonds seldom show a premium, it appears on a separate invoice. We
must often use a bond form supplied by the obligee instead of our
own form.
8)
COVERAGE:
The bond simply identifies the parties and mentions the contractual
obligation covered. The "real coverage" is either a contract
or a statute plus the Laws of Suretyship. So, our bonds are the
same as our competitors'. Only Fidelity bonds covering the honesty
of employees vary as to terms and conditions.
9)
FRAUD OR DECEIT:
Bad faith of an insured will ordinarily relieve a company when it
involves an insurance policy but not on a bond. Once executed, it
remains in force. This is the reason for careful selection and underwriting,
and why we often need a signed application which contains the indemnity
agreement.
CONTRACTUAL
OBLIGATIONS COVERED BY BONDS
We have referred to the principal's "obligation". Its
full meaning should be clear to everyone before dealing in bonds.
It does not refer alone to obligations entered into by a contractor.
Rather, it means the legal (contractual and/or statutory) obligations
entered into by any principal with his obligee. Thus, when a
1)
person seeks a license or permit. or an
2)
estate is being administered by a fiduciary, or a
3)
court requires a bond from a litigant, or a
4)
public official is elected to office, or a
5)
contractor agrees to build a building, or an
6)
employee hires out to an employer,
a
legal obligation is assumed by the principal to perform or execute
the obligation as the contract and/or law requires.
It
is these and various other forms of obligations that we guarantee
when we issue a bond. The specific contractual details control the
"coverage" granted in the bond plus the common law and
statutory laws applying and which we call the Laws of Suretyship.
|
