Once you get into a surety bond contract, you should know that there are five elements that should be present before the law will enforce that guarantee. These elements include competent parties, agreement, consideration, lawful object, and prescribed form.
But first, what is a surety bond?
A surety bond serves as a written agreement that guarantees the performance of an obligation. It usually provides financial compensation to be paid if a Principal fails to perform as specified in the bond contract. A surety bond is not insurance, but a risk transfer mechanism. It shifts the risk of conducting business with the Principal from the Obligee to the Surety.
The surety bond contract is initiated into action when two or more parties create legally enforceable duties that did were non-existent before.
Competent parties refer to persons that enter into binding agreements have the legal capacity to perform. For those who enter contracts that have restricted legal capacities may include, minors, elderly, intoxicated persons, and mentally-disabled persons. Typically, when these persons enter into a binding contract, they have legal representatives that may declare such contracts void.
A corporation can be a competent party to the extent which it may enter a contract based on its implied powers. These corporations may own or sell real estate properties or adopt regulations. An act that goes beyond the powers of the corporation is called an ultra vires act. As a general rule, corporations have no implied power to become a guarantor or Surety on behalf of another party unless such a guarantee is designed for the continuance of corporate goals. Insurance companies are granted such powers to engage in this activity, but most other corporations are not.
Agreement or Acceptance
An agreement is defined as “a manifestation of mutual assent between two or more parties.”
There are three elements in agreement: definite subject matter, offer, and acceptance.
Surety underwriters understand the need for defining the subject matter of an agreement and are familiar with how the laws of offer and acceptance related to surety bonds and indemnity agreements. The bond becomes binding only when it is acknowledged by the Obligee.
Acceptance occurs when there is an act of agreement by both parties. Until this takes place, the offered bond can be recalled or revoked. Similarly, a signed agreement of indemnity becomes binding only when the Surety performs some action based upon it. This “act” is the issuing of a subsequent bond.
Consideration is described as “the price agreed upon for a promise.”
To make a contract effective, something that the law regards as valuable must be given by the promise. It must have been bargained for by the guarantor as the agreed exchange for the promise, and it must be something to which the promisor had no prior right. Consideration may consist of an act, a forbearance, or a return promise.
Consideration in all contracts must be legally sufficient in a sense that is not usually concerned with the adequacy but promises results to the party that requires it.
A contract must have a legitimate object to be legally enforceable. That is why a Surety exhaustively reviews the bond form, its terms, and conditions, to prevent entering into an illegal agreement, where the rights and obligations of the parties involved become confused.
Since the Statute of Frauds in 1677, the law has required that certain contracts be evidenced in writing as a condition of enforceability.
Among them are:
- contracts that cannot be performed within one year after the contract is made;
- agreements to sell an interest in real property;
- promises made in consideration of marriage;
- promises by executors or administrators of estates to pay claims against the estates from their funds; and
- promises to pay for the debt, default, or miscarriage of another.
The last provision requires that surety bonds must be in writing. If a written contract is completed, the courts will not allow it to be altered, whether by oral testimony or other writings or memorandum.
However, there is no general rule of law governing any other formalities for surety contracts. The regulations set forth by most insurance companies allow them to bind themselves on contracts in various ways.
For the most part, any piece of paper that has on it the signature of the president and secretary of the corporation, and that is countersigned by a licensed agent of that company, is binding. It is customary for surety agreements to be signed manually by persons authorized to sign bonds under Powers of Attorney.
There is no particular form required for a contract. Many standard forms have utilized that detail the necessary obligations of the parties in different situations that can be completed by introducing transaction-specific information, such as dates, names, and locations. Other written instruments, such as letters and memoranda of agreement can be binding. These instruments are important considerations that influence underwriters when writing bonds.
Completing the Contract
When contracts are completed and fulfilled, there is a “discharge by performance.”
This means that contracts may be discharged in a variety of ways:
- By termination of agreement
- Performance becomes impossible
- Intervention of statutory laws
Reading between the fine lines of a contract is not only necessary but a crucial requirement before entering into a bond agreement. When competent parties, agreement, consideration, lawful object, and prescribed form are present in a contract, the law will consider it binding upon the involved parties.