What is a Surety Bond and When is it Used?

A surety bond is defined as a three-party agreement that legally binds together a principal who needs the bond, an obligee who requires the bond and a surety company that sells the bond.[1] The bond guarantees the principal will act in accordance with certain laws. If the principal fails to perform in this manner, the bond will cover resulting damages or losses. When is a bond such as this used?

In New York, there are many different Surety Bonds depending on your industry.  For example, you can choose from Alcoholic Beverage Control Bonds, Motor Vehicle Dealer Bonds, Nail Salon Wage Bonds, Private Investigator Bonds and much more.  However, when it comes to Construction Surety Bond types, this list is truly endless.  When selecting the bond for you, there are options to choose from such as, but not limited to, Bid Bonds, Contractor License Bonds, Maintenance Bonds, Payment Bonds, Performance Bonds, Site Improvement Bonds, Subdivision Bonds, Supplier Bonds and more.

“A contract bond is a type of surety bond that guarantees contracts are fulfilled.  These bonds are most commonly used in the construction industry to ensure projects are completed according to the contract.  For this reason, ‘contract bond’ and ‘construction bond’ are often used interchangeably.  If the contracted party fails to fulfill its duties according to the bond’s terms, the project developer can make a claim on the bond to recover financial losses.  Surety bonds are almost always required before work can begin on public projects.  Private project developers can also require contractors to file certain types of surety insurance before work can begin on their projects.”[2]

Although surety bonds have been used to regulate New York’s construction industry for decades, many contractors still have a limited understanding of their purpose and how to utilize them to protect themselves.  Back in 2017, guest blogger Danielle Radabaugh outlined an informative and helpful breakdown of bonding principles in New York construction.  Her articles can be found below.

Surety bonds are crucial to New York’s construction industry because they protect local government agencies, project owners and other financiers from losing the investments. To better understand the purpose behind New York surety bond regulations, contractors should acquaint themselves with the following five principles.

  • Surety bonds are legally binding contracts. A basic surety bond definition
  •  (http://www.suretybonds.com/surety-bond-definition.html) explains that these risk mitigation tools function as legally enforced contracts that bind three separate entities to one another. When it comes to construction bonds, the three parties include the contractor or construction firms that purchases the bond (known as the bond’s strong principal), the government agency or other project owner that requires the bond (known as the bond’s strong obligee) and the company that sells the bond and acts as the contract mediator (known as the bond’s strong surety).

Each surety bond executed guarantees the principal will act in accordance with certain laws specific to the bond’s contractual language. If the principal fails to meet the bond’s stipulations, the bond will be used to pay for resulting damages or losses.

  • New York surety bond requirements vary depending on where contractors work.
  •  Most contractors already know that the federal Miller Act requires separate payment and performance bonds on any publicly funded project whose contract exceeds $100,000. However, state and city governments have the power to enforce additional surety bond regulations per their discretion.

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Other than asbestos abatement work, all construction work in New York is regulated at the local level, meaning the state doesn’t set surety bond regulations. For example, before a contractor can get a street and sidewalk construction permit to work in New York City, the contractor must file a street obstruction bond and a plumber’s bond with the city’s Department of Transportation (http://www.nyc.gov/html/dot/html/home/home.shtml). With each new construction project, New York contractors should always check with the government agency that regulates the geographic area to clarify any and all surety bond requirements.

 

  • Some contractors might not qualify for the surety bonds they need.
  •  Since government agencies use surety bonds as a way to keep unqualified individuals from working in the New York construction market, it goes without saying that some contractors will not be able to get the contractor license bonds they need (http://contractorbonds.com/).

Since surety bonds provide a financial guarantee, surety providers have the responsibility to determine who does and does not qualify for certain bonds. As a neutral third party, sureties risk a potential financial loss with every bond they issue, which is why they have such rigid qualifying standards.

  • Getting a surety bond might cost more than some contractors can afford.
  •  Surety providers calculate surety bond premiums using a number of criteria. The base premium is determined as a percentage of the surety bond amount. For example, two different construction firms each need a $100,000 surety bond. The owner of the first company has a good credit score, so the bond premium will be calculated as 1% to 5% of the bond amount, which would be $1,000 to $5,000. The owner of the second company has a poor credit score, so the premium could range anywhere from 6% to 30% of the bond amount, which would be $6,000 to $30,000.

The basic nature of surety bonds is to protect consumers and government entities from fraud, malpractice and financial loss. For this reason, surety bonds issued in the construction industry are often written to cover the full amount of the project. Since construction projects can be so expensive, this oftentimes means that smaller construction firms are unable to work on larger projects because they don’t have the capital necessary to front bonds that have high premiums.

  • Failing to maintain required surety bonds results in considerable penalties.
  •  When contractors are caught without proper surety bond coverage, several different penalties might be implemented. Contractors that fail to maintain surety bonds as required by law face legal action, penalty fines and even license revocation (https://www.liconstructionlaw.com/construction/crucial-surety-bond-principles/). With these penalties on a record, getting additional surety bonds in the future could be more difficult since surety providers are wary of working with contractors who have had past bonding issues.
John Caravella, Esq

John Caravella Esq., is a construction attorney and formerly practicing project architect at The Law Office of John Caravella, P.C., representing architects, engineers, contractors, subcontractors, and owners in all phases of contract preparation, litigation, and arbitration across New York and Florida. He also serves as an arbitrator to the American Arbitration Association Construction Industry Panel. Mr. Caravella can be reached by email: John@LIConstructionLaw.com or (631) 608-1346.

This is a general information article and should not be construed as legal advice or a legal opinion. The content above has been edited for conciseness and additional relevant points are omitted for space constraints. Readers are encouraged to seek counsel from a construction lawyer who has experience with Long Island construction law for advice on a particular circumstance.

Danielle Rodabaugh is the editor of the Surety Bonds Insider (http://www.suretybonds.com/blog/), a publication that provides in-depth analyses of developments within the surety industry. The publication is sponsored by SuretyBonds.com (http://www.suretybonds.com/), a nationwide surety bond producer that helps contractors understand the legal implications of the surety bond process.

[1] Definition obtained from https://www.suretybonds.com/what-is-a-surety-bond.html.

[2] See https://www.suretybonds.com/contract-bonds.html.

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