Glossary of Surety-related Terms
- Bid Bond
- Bid bonds are a financial guarantee by the surety to the obligee,
usually the project owner, that the contractor will honor his bid price,
enter into a contract and supply the required performance and payment ponds.
The bid bond amount is usually 5 to 20% of the bid amount. If the contractor
fails to honor his bid or can not furnish the performance or payment bonds,
the surety is liable for the difference between the first and second bidder
up to the face amount of the bond.
- Bond Back
- Occasionally the surety will as part of the underwriting requirements
require the contractor/bond principal to have one or more of their
sub-contractors provide performance and payment bonds to its bond principal.
Doing so can help the contractor qualify for larger jobs because having the
sub bonded reduces the risk of financial hardship if that sub fails to
complete or pay its suppliers or crew. We call this bonding back the sub.
- Bondline
- Occasionally a contractor will want to find out if they are bondable and
to what size jobs. At SCP we will, free of charge, perform a limited
underwriting review of a contractor to determine what level of bonding we
would be comfortable with. SCP will establish a single bond size limit and
an aggregate limit of all bonded work.
- Bond Principal
- The bond principal is a surety industry term for the contractor who is
required to furnish the bond. The bond principal is one of three parties to
a bond. The bond principal is the one whose has the obligation to complete
the contract and indemnify the surety if there are any losses to the surety.
- Business Financial Statement
- See Business Financial Statements
- Collateral
- When a contractor submits a bond request that stretches the surety’s
comfort level, the surety will sometimes request that the contractor furnish
collateral in the form of a cash deposit, trust deed on a piece of real
property or some other form of security. This increases the comfort level of
the surety knowing that they have access to the asset if there is a problem
on the job and the surety has to make a payment from the bond. In the case
of cash the contractors still owns the money and earns the interest. Once
the bond is released the collateral is returned to the contractor.
- Completion Bond
- Surety Company of the Pacific does not write completion bonds. A
simplified definition of a completion bond is that the surety guarantees
that no matter what happens to the bond principal the project will be
completed by the surety even if the owner runs out of money.
- Contractor's License Bond
- All contractor are required to post a contractor’s license bond to
obtain and keep their license. In addition all responsible managing
employees (RME) and some responsible managing officers (RMO) are also
required to post a bond. This bond is for the benefit of the public to
compensate them for actual damages if the contractor does not adhere to the
Contractor’s License Laws.
- CSLB (Contractors State License Board)
- The Contractors State License Board (CSLB)
protects consumers before and after they hire building contractors. The CSLB
licenses and regulates contractors in 42 license classifications,
investigates complaints against contractors, and through SWIFT (Statewide
Investigative Fraud Team), works to eliminate the number of unlicensed
contractors working in California. It provides free publications about
hiring contractors and the construction process and maintains an
informational web site and toll-free automated telephone response system
that provide the public with contractor licensing information.
- Current Assets
- Cash, marketable securities, trade accounts receivable, and inventories
(to a certain extent)
- Current Liabilities
- Liabilities that must be paid within one year, including the current
portion of long term debt
- Disciplinary Bond
- Disciplinary bonds are required by the CSLB when a contractor has been
found in violation of certain Contractor License laws.
- Exoneration
- Exoneration is a surety term that describes when a bonded obligation on
the part of the surety ends. This usually does not occur until the warranty
period of a project had ended. Which means that the surety still has
potential liability well after the project is complete. SCP actively seeks
exoneration of all bonds from the obligee.
- General Indemnity Agreement
- The general indemnity agreement is required to be signed by all bond
principals before a bond is issued. The bond principals will include all
owners (and their spouses) of the construction company, the company itself
will sign the indemnity and potentially other related persons or entities.
This document, in very simple terms, states that if the surety incurs any
losses on the bonded job then the indemnitors will reimburse the surety for
all costs. The reason for this agreement is that a bond is not an insurance
policy and the bond principal is responsible for reimbursing the surety for
any costs it incurs to finish the job or pay subs, suppliers or crew.
- Hazardous Materials
- Hazardous material (hazmat), because of its unique and potentially
dangerous properties and long liability tail presents some difficult
underwriting challenges. Reducing the risk for the surety and the bond
principal is very important. Often when a sub contractor is involved, the
surety - SCP included, will require the sub to bond back to the bond
principal to reduce the risk. If the contract is primarily hazmat only a few
sureties specializing in hazmat will even look at the bond request.
- Liquidated Damages
- Liquidated damages (LD’s), by definition are not a penalty for not
completing the job an time, but an estimate of the costs the obligee/owner
will incur because the contract is not completed on time. The LD’s can range
from a relatively low amount of hundred dollars to many thousands of dollars
for every day the contractor is late. High LD’s can severely affect the
contractor’s profitability; therefore the surety looks closely at this item.
- Maintenance Bond
- The maintenance (or warrantee) bond is a financial guarantee that the
contractor will maintain a project for a specified time after completion.
Usually the bond, when required, is written at the same time as the
Performance and payment pond. The bond is usually written as a smaller
percentage of the contract amount, typically 10%.
- Obligee
- The obligee is the first party that makes up the three party contract
that is a bond. The obligee is the entity that is requiring the bond and the
one that benefits from it if there is a problem on the job. The obligee is
usually your customer, whether it be a public agency or a general
contractor. Sometimes a bank or lending institution can be the obligee when
they are trying to protect their investment. Occasionally, there will be
two or more obligees on a bond when multiple entities have a vested interest
in a project. We call this dual obligees and there will sometimes be an
additional charge when there are two or more obligees.
- Payment Bond / Labor and Material Bond
- The payment bond/ labor and material bond guarantees that the contractor
will pay all workers, sub-contractors, suppliers and other vendors that have
supplied labor, materials or equipment to the bonded project. This bond is
usually written with the performance bond at no additional charge. On
occasion the payment bond is written on its own.
- Performance Bond
- The performance bond guarantees the performance of the contractor, that
they will complete the contract at the price stated as per the plans and
specifications. If the contractor defaults the surety must step in and
complete the project or pay to have it completed up to the bond limits. Most
performance bonds are written at 100% of the contract amount and increase
with each change order. The cost of the bonds is based on a percentage of
the contract amount.
- Permit Bond
- Permit bonds are required by certain government agencies. Most of these
bonds are for the protection of the city, county or state to guarantee that
any work done by a contractor is properly completed to their specifications,
these include highway or street encroachment bonds, minor grading bonds,
well drilling bonds and many others.
- Premium
- The premium is the cost of the bond, paid to the surety for providing
the financial guarantee and for performing the underwriting on the
contractor. For contractor license bonds the
premium is fixed amount. For contract
surety bonds the premium charged is always a percentage of the contract
amount.
- Premium Adjustment
- If there is a change order issued on a contract the surety will issue a
premium adjustment notice to charge additional premium if the contract goes
up.
- Prevailing Wage
- Almost all public works construction projects are required by the Davis
Bacon Act to pay all workers who work on the public works project the
prevailing wage in the local area. By definition established a long time ago
this wage approximates the local union scale for the particular trade. This
rate is usually much higher than the wages paid for private work and the
contractor has to adjust their bid accordingly or face serious consequences.
Certified Payroll: The certified payroll is one means to verify
compliance. All contractors working on public work project are required to
provide on a weekly basis a certified copy of the weekly payroll on a
specific project naming all workers and showing all wages, deductions and
benefits paid including the check number.
DLSE (Division of Labor Standards Enforcement): If you don’t comply
with the prevailing wage rules the DLSE can come after you and the penalties
are steep.
- Quick Assets
- The variance between cash plus trade accounts receivable over current
liabilities.
- Reinsurance
- Most sureties will negotiate a contract with a large reinsurance
company. The reinsurance company will take a large portion of any major loss
a surety might have. On large requests the approval of the reinsurance
company may be required.
- Subdivision Bond
- Whenever a contractor or developer sub-divides or improves a piece of
property the local city or county planning or zoning department will often
require subdivision bonds. The surety is providing a financial guarantee
that developer or contractor will properly complete all of the offsite
improvements the that are required as a condition of the permit. These
requirements could include all utilities, streets, curb and gutters,
sidewalks, grading, landscaping, survey monuments and more.
- Surety
- The basic definition of surety is that a person or other entity, like a
surety or insurance company guarantees to stand in the place of another and
guarantee their performance of a specific obligation.
- Surety Bond
- See Bid Bond
Completion Bond
Contractor’s License Bond
Disciplinary Bond
Maintenance (or Warrantee) Bond
Payment Bond/ Labor and Material Bond
Performance Bond
Permit Bond
Subdivision Bond
Union Welfare Bond
- Surety Company
- Surety Company of the Pacific (SCP) performs the underwriting or
investigation of the contractor to verify that the contractor has the
character, capacity and capital to successfully complete the bonded project.
Upon approval the surety issues the bonds thereby guarantying that should
the contractor fail the surety will use its own money to honor the terms of
the contract.
- Underwriter
- The underwriter is the person who works with the contractor and
assembles all of the information, analyzes it, makes a recommendation and
gets a decision made. The relationship between the underwriter and the
contractor is very important. The underwriter will end up knowing a lot
about the pond principal and his or her company.
- Underwriting
- Through the underwriting process the surety will investigate the
contractors character, capacity and capital to determine if the contractor
is qualified, by the surety’s standards, to complete the project. This
process is very much like qualifying for a loan in the same amount as the
bond request.
- Underwriting Committee
- Larger bond requests will be presented to an underwriting committee made
up of company executives for a joint approval.
- Underwriting Requirements
- For contract surety bonds the contractor will be required to submit a
considerable amount of documentation including: a comprehensive application
form, information about the project being bonded, complete financial records
for the business and the owners of the company, references from customers
and trade suppliers and more. In addition the underwriter will pull credit
reports, CSLB history and more.
- Union Welfare Bond
- Union contractors are, on occasion required by their Union to post a
union welfare bond. This bond is a financial guarantee that the all the
union benefits deductions from their employees are made to the union’s trust
fund.
- Working Capital
- The excess of current assets over current liabilities - viewed as fund
available to the company
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