Understanding the Terms and Conditions of a Surety Bond

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Why should I learn about the terms and conditions of a surety bond? Isn’t this the job of a surety or an underwriter?

Yes, it is. But in the spirit of transparency, we feel that our potential clients and existing clients should understand the terms and conditions as well.

By having a good understanding of these, you will have an in-depth look how it works, why some people cannot be bonded, and why some bonds are riskier than others.

Understanding the Terms and Conditions of a Surety Bond

AN UNDERWRITER’S JOB

You are right. Knowing the terms and conditions of a surety bond falls primarily on the shoulders of an underwriter. It is the underwriter’s duty to examine every word included in the terms and conditions.

Who are these underwriters? To put it simply, underwriters are surety bond experts. They cannot be less than.

It is a strong advantage if an underwriter a CPCU designation (Chartered Property Casualty Underwriter) attached to his or her name. That acronym comes with a list of skills that are used in reviewing bond forms, Agreement of Indemnity, contracts, pertinent documents, underlying law, and the principal’s character.

 

TERMS AND CONDITIONS

 

Underlying Law

Sureties use a standard bond form. There will be minor deviation per state, but the format will remain the same. In bond forms (especially license and permit bonds), you will see this condition:

“The Principal shall faithfully perform the duties and in all things comply with the laws, statutes, and ordinances including all amendments thereto.”

The principal, by the way, is the person who will purchase the surety bond. Usually, the underlying law will be stated in the bond form so as to eliminate confusion. For example, Section 83-17 of the Mississippi Code Annotated.

The underwriter will have to study this particular section of the Mississippi Code Annotated. In order to do his/her duties well and avoid future claims, the principal must have a good understanding of everything that’s been stated in that particular section of the law.

Both the principal and the surety will not be able to know the complete obligations until they read the entire section.

And sometimes, there are state laws that conflict with federal laws. When this happens, it is important to ask your surety which one you should follow and whether the Supremacy Clause be applied to it or not?

 

Onerous Conditions

Onerous conditions are those conditions that may prove to be too difficult for the principal to perform or complete. These conditions increase the risk of a bond. These conditions may be mandated by a statute, ordinance, regulation, or a private contract.

An underwriter will carefully identify and study these conditions. Some of these are as follows:

  1. The Bond’s Penalty Amount

Commonly referred to as the Penal Sum of the Bond. If the obligee (beneficiary of the bond) asks a higher bond penalty amount, the surety will perceive this to be a reflection of the exposure of the principal to an aggregate liability. The obligee is probably concerned that the principal will not be able to perform the obligations, hence the high penalty amount.

However, there are some penal sums that are high because of previous problems that occurred in a specific industry. Because of this, new regulations have been made which includes an increase in the bond amount.

There are also large bond amounts that are determined by such factors as potential or prior revenues or the number of the business’ locations.

 

  1. Aggregate Liability

This is the maximum amount that the surety will be liable for. The client must know this amount in the event of loss under the bond. There are bond’s that will last for years, but the validity of the bond will not affect a surety’s total liability.

 

  1. Cumulative Liability

There are some conditions that will require the full bond penalty to be available per year that the bond is in effect. This is what’s known as cumulative liability. Some obligees may ask for a continuation certificate from the surety as long as it is cumulative in nature.

 

It is still important that you have a good understanding of your own bond no matter how taxing the definitions are in the beginning. Don’t worry, you will not be alone in figuring out your bond’s terms and conditions. An exemplary surety will patiently guide you every step of the way.

 

Need more information about surety bonds? Contact us!

 

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