Surety Bond Fundamentals

From Basic Laws, Co-Surety Roles to Subrogation Rights

surety bond fundamentalsIn this article, we tackle the surety bond fundamentals – from its basic laws to roles of the co-surety play and subrogation rights to have a deeper understanding of how sureties work (it’s not just about issuing bonds, you know?).

But first, we review the laws of suretyship (which has evolved from English common law that involved personal sureties) that still apply today.

 

Fundamental Laws

Suretyship is a relation which exists where a party has assumed a financial obligation (Surety) to support another party (Principal) that has undertaken a primary obligation to a third party (Obligee).

  • There should be fair and honest dealings between all parties involved.
  • The Surety will be released from its obligation if, and when, there is evidence found of any misrepresentation, fraudulent involvements, or covering-up of material facts by the Obligee and Principal with the intent to damage the Surety.
  • The Obligee and Principal must not materially alter the terms and conditions of the contract without the Surety’s consent.
  • In case of a default by the Principal, the Surety has the right of indemnity from the funds or assets of the Principal.
  • For more than one Surety, where the only one pays upon the default, the one who made payments is entitled to contribution from the other.
  • For unclear and ambiguous contracts, the party that drew up the contract will be strictly held responsible.

 

Role of Co-Surety

A Co-Surety is where two or more sureties share the same obligation. Surety underwriters sidestep potential risks on massive bonds or accounts by joining together as co-sureties.

Co-surety agreements entail participating sureties to be joint and several as to their liability to the Obligee. The liability, which may be limited or unlimited, of each Co-Surety, is described in the co-surety agreements between the parties.

This is a method of sharing risks among surety companies that differs from the approach of reinsurance. With reinsurance:

  • An Obligee has no direct relationship with the reinsurer. Thus, the Obligee has no right of action against the reinsurer in case of a default by the Principal or a failure of the Surety to honor its obligations on the bond.
  • A reinsurer is liable only to the Surety to the extent of the terms and conditions of its contract with the Surety.

Most reinsurance agreements exclude Co-Surety obligations and involve special acceptance to prevent the reinsurer’s overexposure on the same account for different sureties.

There is a Co-Surety surety bond that is guaranteed by two or more surety companies! Co-Sureties are bound jointly and severally to the Obligee. However, the bond often indicates the liability limit for each surety in dollar amounts on the bond.

Larger construction projects use Co-Sureties where the bond amount exceeds a Surety’s allowable limit within that jurisdiction. Therefore, two or more sureties are required to cover the obligation. They may be contractually bound in different sums, but Co-Sureties are bound to pay equally as much as the limits of their corresponding obligations.

 

Subrogation

Subrogation is the Surety’s right to impose a third-party’s rights against the Principal. The Surety must have already made payments to the third party to apply subrogation rights.

Once the owner declares a default on the contractor and the Surety completes the contract, the Surety is granted the rights to undispersed contract funds. The Principal must fully reimburse the Surety for any incurred losses due to the Principal’s default. If the surety finds proof that the default allegations are wrong, the Surety and Principal will together rebuff the Obligee’s claims.

To add to its subrogation rights, the Surety also obtains protection against financial losses with the general indemnity agreement.

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