Odds are that if you’ve ever needed a surety bond, this very question has crossed your mind. On its face, it’s easy to think of bonds as an insurance product. Your insurance broker is potentially involved with getting bonds and many of the largest property and casualty insurers also have surety departments. However, it’s not that simple.
First of all, surety is more akin to a credit product than an insurance one. You’ve probably had a conversation where the difference between a two party agreement (insurance) and a three party agreement (surety) was discussed. What the surety is ultimately doing is guaranteeing a contract between two parties—putting their formidable financial strength behind your company and its performance.
As an economics major, one of my favorite acronyms is TANSTAAFL (there ain’t no such thing as a free lunch). Indemnity is a core principal of the surety relationship, whereby if a company causes the surety a loss, the surety will seek indemnification from said company and potentially ownership. The general indemnity agreement (GIA) outlines the legal responsibilities and guidelines for both the surety and contractor. Here are three broad stroke takeaways:
- If you cause the surety to pay out a loss on your behalf, they have the right to seek indemnification from either your company (corporate indemnity) or you/other owners (personal indemnity).
- The surety has several legal options outlined in the GIA when it comes to projects/customers in a claim scenario. They can entail either funding the existing contractor on the job (loaning money to complete current projects), replacing their contractor with a new contractor coming in mid-project, or paying out their obligation of the full penal sum (face amount) of the bond. Most claims result in the surety working with/funding the existing contractor to close the project as efficiently as possible—this is typically the fastest and least costly option for both the surety and contractor.
- The surety is in the driver’s seat when it comes to these options. They are legally responsible for the fulfillment of the contract and have the ability to replace you as a contractor if they deem that the best option. Cooperation and communication with your surety team during a claim scenario are of the utmost importance. If handled properly, the surety can be a strong ally and legal resource.
Aside from the above, one of the thorniest issues with GIAs is the surety requiring the business owners and their spouses to sign when personal indemnity is required. While it may seem unreasonable and excessive to require spousal signatures, the surety is protecting itself against potential issues down the line in an indemnity situation. If a company has a loss and only the owner has signed the GIA, they may attempt to transfer assets to their spouse to shield them from the surety. By having both spouses sign the GIA, this issue is averted before it becomes a problem. As a company grows and shows a profitable and successful track record, the surety will begin to explore avenues to limit and eventually eliminate personal indemnity.
Surety is a phenomenal tool for contractors entering the public marketplace. It ensures that public entities are working with qualified, capable and sufficiently capitalized firms, as well as guarantees the general public is receiving exactly what their tax dollars are paying for. While every company operating and using bonds has a GIA in place, many owners don’t understand or haven’t had the GIA and its nuances explained. If there are any questions you have related to the GIA or surety in general, please feel free to reach out—we’re happy to assist.