What Are Bonds?
A BOND is a financial guarantee arranged among three parties:
- The Obligee, the party requiring the Principal to have the bond;
- The Principal or Indemnitor, the Purchaser, who is required to have the bond; and
- The Bonding or Surety Company, who, by issuing the bond, guarantees that the Principal will fulfill its legal financial obligations to the Obligee as required under the bond agreement.
Take for example, a CONTRACTOR'S LICENSE BOND. The State of Oregon Construction Contractors Board requires contractors to purchase a bond before they can be licensed to work as a contractor in the state. The State CCB, the Obligee, requires the contractor, the Principal, to be bonded by a Surety Company. The bond is a guarantee to the State by the Surety Company that the Principal will comply with the laws and regulations governing contractors. The bond protects the public from possible business misconduct by contractors.
Another example is the FIDELITY or EMPLOYEE DISHONESTY BOND. This bond is often purchased by janitorial and housecleaning businesses. It is designed to guarantee the honesty of employees. It is a guarantee against losses arising from Employee Dishonesty, such as an employee stealing money or other valuables from a customer's premises. Upon conviction of the dishonest employee, the Surety Company will indemnify the Principal for losses caused by the employee's dishonest behavior.
The most common types of bonds written at our agency are CONTRACTOR LICENSE BONDS and EMPLOYEE DISHONESTY BONDS. There are many other types of bonds, but these two are the ones you will encounter most of the time.
A BOND is NOT INSURANCE. Bonds are generally priced and written under the assumption that losses will not occur. Insurance is priced and written under the assumption that losses will occur, so the premiums charged include paying for such losses. With insurance, if a loss occurs and is covered, the insurance company will pay for the financial losses suffered. With a bond, if a loss occurs, it is the obligation of the Principal, the purchaser of the bond, to resolve the loss. Only if the Principal defaults on meeting his legal financial obligations under the bond, then the bonding company must take care of the loss, to the limit of the bond.
For Contractor License Bonds, the Surety Company always runs a CREDIT CHECK on the Principal. For EMPLOYEE DISHONESTY BONDS, normally the risk of loss is so low that a credit check is usually not made for bonds of $10,000 or less. For more complex bonds, such as Performance Bonds or Mortgage Broker Bonds, the Surety Company usually requires business and personal financial statements and credit references in addition to the Credit Check to determine if it will issue a bond.
CREDIT HISTORY
Many businesses have difficulty getting bonded. This may be due to a bad credit history. This may include unpaid bills, unpaid child support, and bankruptcy. However, it may be also be due to a lack of credit history. The Principal may not have established a history of credit (lack of a bank account, credit cards or history of installment payments), and the Surety Company can find no evidence to determine that the Principal has proven himself worthy of bonding. In these cases, bonding may be obtained, but at a much higher cost than normal.
CLAIMS
If a claim is made, it is important that the Principal respond immediately to the Surety Company's request for information to minimize the cost to all parties. Not resolving the claim promptly results in the current bond being cancelled, and generally prevents the Principal from obtaining future bonding. If the Surety Company pays the loss, it requires the Principal to make reimbursement of the loss and expenses incurred.
UNRESOLVED PRIOR BOND CLAIMS
If the Principal has been bonded before and has claims against his prior work, he will not be able to obtain a bond until those claims have been settled.
INDEMNIFY
To indemnify means to guarantee to another repayment in case of a loss. On the bond application, the Principals of a business and their spouses agree to personally indemnify the bond. If a loss occurs, they guarantee to resolve the loss, and to repay the Surety Company if it pays out to resolve the loss. Personal indemnification represents the Principal's commitment to the integrity of the business entity and to the Surety Company.
COLLATERAL
A surety company may request collateral (the payment of an additional amount of money) to reduce the risk a surety company assumes when issuing a bond. Collateral may be provided by cashiers checks or certificates of deposit. After all obligations of the bond have been met, the Obligee releases the Surety Company from their obligation under the bond and the collateral is returned to the Principal. This normally occurs several years after the expiration of the bond as long as no claims have been filed against the bond.
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