Suretypedia’s Guide to Bond Claims

11-9-2019

Many people find the attributes and outcomes of surety bond claims confusing because they are very different from traditional insurance policy claims.

The first and most fundamental difference is that unlike an insurance policy, which protects the individual or business who purchased the policy, the “Principal” who purchases a surety bond is not the protected party; instead the bond protects certain other parties who may be harmed by the actions of the Principal, and they are the ones who file claims. The second difference is that unlike a claim on an insurance policy, a claim on a surety bond is not the result of an accident or force of nature; it is the direct result of an action or inaction on the part of the bond Principal, usually the business or business owner who purchased the bond. Finally, unlike insurance, when the “Surety” company pays a claim, it has the right to seek reimbursement from the bond Principal.

This article dives into these issues and more such as what you should do if a claim on your bond is filed or you wish to file a claim on someone else’s bond.

Do bonds protect the business owners who purchase them?

The short answer — No. Surety bonds are generally required by government agencies to protect the public from harm should a business owner violate license law or fail to meet the terms of a contract. Even though the surety bond protects another party, businesses are required to purchase surety bonds as part of a licensing requirement or before entering into a contract.

If it doesn’t protect the business who purchased it, what’s the point?

Think of a surety bond as an entry fee into an industry or contract. It is a cost of doing business required by an “Obligee” (What is a Surety Bond Obligee?) such as a project owner on a construction job or a government agency that regulates a specific line of business. Unfortunately, it’s a take it or leave it deal; however, one positive way to think of surety bonds is as a justified barrier to entry in your business. Your company has purchased protection for the public or your client, reducing the likelihood that you will be undercut by undercapitalized, inexperienced or even unscrupulous competitors. Now back to surety claims…

What actually causes a surety bond claim?

Surety bond claims can be caused by a variety of circumstances and, as mentioned earlier, claims on a surety bond are not the result of accidents that happen from time to time and therefore do not meet the definition of insurance. Instead, surety bond claims are usually the result of some violation of law or failure to comply with a contract stipulation. Depending on the industry of the bond Principal and the type of bond needed, a variety of different violations can result in a claim.

Below is a breakdown of the most common bond types and examples of common violations that may result in a claim:

Contractor’s License Bond
- Failure to comply with construction timeline
- Walking off of a job
- Failure to pay laborers or suppliers
Employee Dishonesty Bond
- Theft by an employee from your business or while working on a customer’s property, usually evidenced by a conviction.
Court and Probate Bonds
- Failure to properly disburse estate assets to the heirs.
- The court upholds the original judgement the Principal is trying to appeal.
Bid Bond
- The Contractor was awarded the project, but declined to sign the contract.
Performance Bond
- Failure to perform the work specified in the contract.
Utility Deposit Bond
- Failure to pay the monthly bill owed to the Utility Company.
Lost Security Bonds
- The new security was issued fraudulently and the original was never lost.

Who pays for a surety bond claim?

This is where it gets really confusing. While the Surety exists to ensure payment is made, the bond Principal who purchased the bond is ultimately responsible for reimbursing the Surety in the event a payment on the bond is made. While the payment is initially made by the Surety, the indemnity agreement (we’ll get to this next) establishes who the Surety can recover from (i.e. the Indemnitors) and specifies other types of recoveries such as claims expenses.

What are indemnity agreements and how do they impact claims on surety bonds?

The indemnity agreement is a contract which, when appropriately executed, supports the Surety’s statutory right to seek reimbursement from the Principal in the event of a claim payout by specifying who the Surety can seek recovery from i.e. the Indemnitors and specifies other types of recoveries such as claims expenses. Should a claim payout occur, the Surety relies on the indemnity agreement to recover expenses incurred in investigating, adjusting and defending a claim. The Surety may have multiple parties they can recover from depending on the level of indemnity collected. If a claim is paid, the Surety will first look to recover from the business then its owners and finally the spouses of the owners. In the event indemnity is no collected, the Surety’s collection ability is drastically limited and, in the event the business is insolvent, the Surety may never be fully reimbursed.

How can you prevent a claim from happening?

To avoid the unfortunate circumstance of a bond claim, business owners should read and understand the obligations set forth in the bond form. Bond forms explicitly state the obligations of each party, including the bond Principal, or reference the applicable laws/statutes that must be followed. In general, adherence to industry best practices and licensing law will help bond Principals avoid questionable or illegal business decisions, which could result in a claim.

What can you do if a claim is filed on your bond?

The best action a bond Principal can take in the event of a claim is to communicate with and respond to the Surety company claims representatives. The Surety relies on the Principal to provide them with information and documentation to help the Surety defend the Principal against a claim. The Surety is often bound by statute to respond or pay a claim within a certain period of time, so timely, organized communication is vital.

In the event that the Principal does not have a reasonable defense, the Surety must pay the claim, but Surety companies will often work with a responsive Principal on payment options to keep the business operable.

There is significant potential for conflict between the Claimant, Principal and Surety throughout the surety bond claims process. Unlike insurance, where the insurance company can make their customers happy by simply paying the claim, surety bond Principals do not want the Surety to pay the claim. Surety claims often impugn business’s reputation and inhibit its ability to operate; however, businesses should be held accountable for acts that could cause harm to the general public. Frustrations may arise should there be disagreements between the Surety, the Principal and the claimant (often the Obligee) in how the claim is handled and the Surety’s ultimate decision on a claim’s validity. The Surety is required to take a neutral stance and review all of the documentation provided in conjunction with the statutes or contract underlying the bond. Parties to a claim have the ability to dispute a Surety’s decision through litigation, but this process is often time consuming and expensive.