Chapter 8 Flashcards
In what ways are surety bonds not like insurance policies?
(1) There is no actuarial rating for surety bonds as the surety company merely makes an assessment as to whether a bond should be issued or not, i.e., sureties assume that no losses will be incurred. (2) Three parties are involved in surety agreements, while for insurance policies two parties are typically involved (life insurance is the exception with three party beneficiaries). (3) Surety bonds protect against default for any reason while insurance provides protection for specified losses. (4) Insurance premiums, in the aggregate, are priced so as to cover losses incurred while surety bond premiums cover primarily administrative costs.
How is it determined that a contracting firm has exceeded its bonding capacity?
The bounding capacity of a firm refers to the total value of the uncompleted construction work under contract. Thus, the total value of uncompleted work on hand will be compared against the bonding capacity. If all work consists of bonded contracts, one way that the bonding capacity could be exceed is by the insurance of sizable change orders by an owner or owners of existing projects. Of course, this would only occur if the contractor was very near the bonding capacity prior to the issuance of the change orders. If a contractor is working near the bonding limit, it is clear that the bonding capacity could be exceeded by a large margin if several contracts for unbonded projects are added to the workload. The unbonded workload of a contractor could also be of such magnitude that the bonding capacity is exceed and then no additional projects could be undertaken.
What is the limit of liability of a surety if the contractor defaults?
In the event of a contractor default, the surety would be expected to complete the project under the terms of the performance bond. Two possible options may be available to the surety. The first is that the owner could undertake the completion of the project in which case the limit of liability is the face value of the bond. The second is that the surety could undertake the completion of the project in which case there is no limit to the liability of the surety, i.e., the surety could incur losses in excess of the face value of the bond if it assumes project completion responsibilities.
4.) What does the bid pond promise to the owner?
It is a promise to the owner that in the event that the contractor (provider of the bid bond) is awarded the contract, the contractor will provide the required bonds and the contractor will enter into a binding agreement with the owner. Failing to provide any of these, the contractor agrees t forfeit the face value of the bid bond.
5.) What rights does a surety have in the event of a contractor default?
The surety essentially “steps into the shoes” of the contractor and thereby it gains any rights that the contractor may have had.
6.) What party or parties are given the most protection by a performance bond? By a payment bond?
The performance bond gives primary protection to the owner as the cost of project completion (assuming no owner changes) at the agreed price is virtually guaranteed. The payment bond gives primary protection to subcontractors and suppliers by assuring them that they will be paid. The payment bond also provides protection to the owner in that the owner has greater assurances to the mechanic’s liens will be filed and that double payments for work performed will not be required.
7.) Give an example in which a surety may not be forced to honor the bond in the event of a contractor default.
If the owner makes payments to the contractor far in excess of the value of construction completed to date, the surety may be released from its obligation on the bond due to the owner’s negligence. In addition, if the owner issues change orders which might be regarded as constituting cardinal changes, the surety may be released from honoring the bond.
