These questions and answers are for the benefit of our less experienced contractors , or those who have not performed bonded work before. 

The questions and answers relate to Payment and Performance Bonds.  If you have questions regarding other types of bonds, please contact our office and we will be happy to answer them. 

1) What is a Surety Bond?

A bond is a three party agreement between the surety, the principal, and the obligee.  In the context of a Payment and Performance Bond, the principal is the contractor applying for a Bond.  The obligee is the one requiring the bond and may be an owner, public agency, or a general contractor. the surety is the company that writes the bond guaranteeing to the obligee that the principal will perform according to the terms of their contract with the obligee.  It is important to understand the differences between surety and insurance (see question #4). 

Other types of bonds work in the same basic fashion.  The obligee may be a government agency requiring a bond (i.e. a Contractors License Bond, Sales Tax Bond, etc.).  The principal is the entity that is responsible to meet the obligee's requirements, and the surety company is still the one that has to stand behind it's principal and perform if the principal fails to do so.  Reviewing the "Types of Bonds" will help to explain these relationships further.  

Regardless of the type of bond involved, it is important to remember that the principal is primarily liable for the performance of the obligation.  The surety is only liable if the principal fails to perform. Keep in mind that if this occurs, the surety will seek reimbursement from its principal.

 2) How do I get a bond? What is the process?

With the exception of very small jobs, public entities (school districts, cities, parks and recreation departments, etc.) always  require their contractors to provide them with Payment and Performance Bonds.  Frequently, a private owner will also require a Payment and Performance Bond.  In the private sector, the owner and contractor will agree on a negotiated amount.  In the public sector, all jobs are bid on by a number of contractors.  The job is awarded to the successful bidder.  In order to bid on a project, you must first obtain a Bid Bond.  If you are the low bidder and are awarded the contract, you must obtain a Payment and Performance Bond.

Assuming you want to do work on a public works job, your first step in the bonding process is to select a project you want to bid on, and prepare your bid.  Your next step is to select a licensed insurance agent to represent you (if you are reading this page then you must be on the right track)! The vast majority of surety companies will not allow you to deal directly with them- they require that you go through an agent.  Your agent will review with you the various information and documents required by the surety.  The surety is interested in, among other things, your work experience, financial condition, bonding history (if any), credit history and current work on hand.  This information will enable your agent to submit your bond request to the sureties that are most likely to issue you bonds, and on the most favorable terms (fewer or no collateral requirements and lower rates). 

Once your agent has submitted your bond request for a bond, the surety will advise your agent if it's willing to issue you a bond, and if so, on what terms.  The surety will indicate the largest bond it will issue for you, and what your bonding capacity will be.

Assuming your agent has found a surety that will issue you a bond, the surety will issue you a Bid Bond which will allow you to bid on the project you have chosen.  The public agency will not allow you to bid on a project without a Bid Bond.  By issuing the Bid Bond, the surety is basically saying it will issue the Payment and Performance Bonds if you are the successful bidder.

3) Do I have to have an Agent?

Yes, in most cases sureties will not issue Payment and Performance Bonds on a direct basis- i.e. you have to have an agent.  Your selection of which agent to use is very important.  Many insurance agents deal primarily with auto insurance, home owners insurance, life insurance, etc. and know very little, if anything, about surety bonds.  Be sure you select an agent that is familiar with surety bonds, and is appointed by different sureties to transact business with them. A good surety agent will also work with you to obtain more favorable terms and increase you bonding capacity, even if it means changing sureties.

4) What is the difference between insurance and surety?

The major difference is that with a surety bond, you will be expected to hold the surety harmless (i.e. you make sure they don't suffer a loss), or reimburse them for any losses and expenses they do incur by your failure to meet the requirements of the bonded contract.  You will be required to execute a General Indemnity Agreement ("GIA") promising to reimburse the surety for any losses.  For instance, if you fail to pay a supplier or a subcontractor, and the surety has to pay, it will seek to recover its losses from you.  Similarly, if you fail to perform the work on your contract or perform faulty work and the surety has to complete the work,  it will look to you for reimbursement of the completion costs.  Therefore, it is important that you bid your work correctly and do your best to complete the work according to the terms of your contract.

5)  What is the difference between a standard market surety and a specialty surety?

A standard market surety only writes bonds for well established contractors, with good work experience, good credit history who are financially strong.  They will write larger bonds and provide their contractors with larger bond programs.  Because they are dealing with strong, experienced contractors, their risk is lower and, therefore, their premium charges are lower.

A specialty surety will write bonds for contractors who have less work experience, lower credit scores, who are not very financially strong, etc.  Because their risk of loss is higher, their premium  rates are higher and they are not willing to issue as large of bonds or extend large bonding capacity.  To lessen the likelihood of a loss, a specialty surety will usually require its contractors to provide collateral and/or agree to the use of Funds Administration (explained later).  Collateral is often taken in the form of cash or cash equivalents such as Irrevocable Letters of Credit ("ILOC"), Certificates of Deposit ("CDs"), etc.  Real estate is also taken as collateral by some specialty sureties.  The amount of collateral depends on the amount of the bond or bonds and the strength of the contractor. 

All sureties will require their contractors to sign a GIA whereby the contractor promises to pay the surety for any losses it suffers.  A standard surety typically requires its contractors to sign for corporate liability only.  A specialty surety will require that the contractor sign as a corporation if applicable, but will also insist the key people in the company sign as individuals.  Therefore, if there is a loss and the corporation is unable to reimburse the surety, the surety can seek recovery from the individual indemnitors.  Frequently, the specialty surety will demand the indemnity of the spouse of the key person with the contractor.  If the surety is still not comfortable with its risk position, it may require the indemnity of third parties the contractor knows.  Of course, the surety will also seek recovery from any collateral they may have taken.

6)  Are there any programs available for small and emerging contractors to assist them in obtaining bonds?          

Yes, there are such programs.  The most well known is the Small Business Association Bond Guarantee Program run by the Federal Government.  The SBA offers guarantees to sureties who participate in the SBA program.  Basically, the program guarantees that the SBA will reimburse sureties for 70% to 80% of any losses and expenses they suffer by reason of having issued a bond to one of their contractors.  This program is limited to small and emerging contractors performing work on Federal projects.  If you are interested in learning more about the SBA Bond Guarantee program, feel free to contact our office, or you can visit their web site at http://www.sba.gov/aboutsba/sbaprograms/osg/index.html

Some public agencies throughout the country also provide assistance to small and emerging contractors.  One of their incentives in providing assistance is to encourage sureties to issue bonds to contractors on their projects who otherwise couldn’t obtain bonds.  These contractors help to keep the bids on the Federal projects competitive.  CIA works closely with an agency that contracts with public entities providing incentives to sureties to bond the program contractors.  The agency has contracts with such public agencies as the City of San Francisco, the San Francisco Airport Authority, the City of Los Angeles, Los Angeles Community Colleges, the Los Angeles Unified School District and the San Diego Airport Authority.  These public agencies put up collateral on behalf of their contractors to entice surety companies to issue bonds.  They also pay for Funds Administration Services which is required to obtain a bond through the programs.  This assistance programs also pay for the services of a program CPA to prepare financial statements required for the underwriting process.  If you are interested in learning more about these programs, please contact our office.  You must deal with one of their appointed agents.  Yes, CIA is appointed with them.

7)  What is Funds Administration?      

Funds Administration is an underwriting tool often utilized by surety companies and lenders.  Essentially, it is required when the entity extending credit wants funds paid to a third party to disburse the proceeds on behalf of the contractor.  The Funds Administration Company acts similar to an escrow service and provides reasonable assurance that the right people get paid at the proper time.