Continuing our series on how the COVID-19 crisis is affecting certain bond types, Suretypedia examines how Utility Deposit bond form language and grace periods granted by utilities may increase Surety carrier liability.
Suretypedia’s Guide to Bond Forms
Author: Suretypedia Team
Posted On: 11-19-2019
Surety bonds are among the oldest contracts in the world; however, they are often misunderstood in the insurance marketplace. The agreement underlying a surety relationship is known as a “Bond Form.” This article seeks to provide the ins and outs of the parties, structure and language privy to this often confusing document.
What is a Bond Form?
A bond form is a contractual obligation between the Principal, Surety & Obligee, which have the following roles within the agreement:
- Principal: The principal is the individual or business guaranteeing their compliance with a law or performance with contract referenced by bond form.
- Surety: The Surety provides the financial backing for the bond and, in the event of a valid claim not remedied by the principal, will provide payment to the Obligee for losses sustained.
- Obligee: The Obligee is the entity that requires the bond of the principal and is protected by the bond.
The bond form dictates conditions the parties must adhere to and guarantees payment to the Obligee should the principal fail to satisfy any of its obligations under the bond. Bond forms, unlike most contracts, are non-negotiable agreements typically created solely by the Obligee. While this gives the Obligee the ability to write the Bond Form in ways that favor those who may suffer losses caused by the principal, Obligees often seek feedback from sureties and other industry groups on provisions that are enticing to Principals and Sureties as well.
What’s in a Bond Form?
Although bond forms are written by the Obligee and may contain specific language related to the bond requirement, most bonds share common language that sets forth the obligations and/or rights of the three parties. The typical conditions are known as General Clauses, the most common of which are described below:
- The Preamble: This clause typically starts with the words “KNOW ALL MEN BY THESE PRESENTS,” and then the names of the three parties (surety, principal, and obligee) to the bonded obligation.
- This clause connects principal and surety to the obligee’s requirements.
- In most cases the bond penalty is specified in this clause.
- The Preamble Part II: Typically starts with “THE CONDITION OF THIS OBLIGATION IS SUCH THAT” and states the nature of the guarantee/obligation the principal has entered into.
- This clause identifies the underlying contract or law the bond guarantees and, in some cases, will reference statutes or regulations by number.
- Reference is often made to the underlying statute, ordinance or regulation, but is rarely spelled out completely. These statutes can be searched via Google for clarification.
- Words of Agreement: States that the principal shall comply and perform its obligation pursuant to the terms of the underlying law, regulation or agreement.
- States that if the principal performs the obligation, the bond terminates according to the underlying law, regulation or contract.
- If the principal fails to perform or be in compliance with the obligation, the bond shall remain in full force and effect.
- Terms & Conditions: In many cases there is language added to the bond providing additional conditions. These conditions may include a cancellation clause, limit of liability, etc.
- Identifies whether the bond will be cancelled by a specific expiration date or if the surety must cancel the bond with the Obligee (“cancellation provision”).
- If specific expiration dates are used this will state if the bond can be continued by a continuation certificate.
- If the bond should remain in full force and effect you should find a cancellation clause, such as “The Surety can cancel this obligation by providing written notice to the obligee with 30 days notice.” The cancellation provision also may state if the notice needs to be mailed certified and where to be sent.
- The Bond Form may limit the liability of Surety with language like “Regardless of the number of years this bond has been in effect or premiums paid the Surety’s exposure is limited to the face amount/penal sum of the bond.” It is also important to note the Surety’s aggregate exposure, regardless of the number of claimants, is limited to the penal sum of the bond.
- Key Dates and Signature Block: the bond will usually the date the bond has been signed and sealed along with a defined space for Principal and Surety signatures.
What if the Obligee Doesn’t Have a Specific Bond Form??
You may need a “Generic” bond form. As the term implies, generic bond forms are templated forms which can be tailored for a variety of bond requirements. Typically, these forms are used when municipalities do not have bond forms available for a specific requirement. Generic bond forms are often crafted by the Surety company, rather than the Obligee and, as such, generally have language that is more favorable to the Surety. The Surety’s generic form should be reviewed by the Obligee prior to issuance of the bond so they can verify the form is acceptable. Much like Obligees, Sureties write their generic forms on a take it or leave it basis.
Why do Surety Companies Underwrite Some Bonds Differently than Others?
Surety companies may employ more stringent underwriting on certain bonds because the limit is higher or the activity necessitating the bond is inherently more risky. However, when these conditions are roughly the same, you may want to dig a little deeper into the language of the bond form. Onerous conditions, such as the ones cited below, increase the risk that the Surety will pay claims and expenses in excess of the premiums generated on that class of bond. It is still possible to obtain bonds containing these conditions; however, Sureties may be more conservative in their underwriting dependent on the condition. Below is a list of onerous conditions seen frequently in the marketplace along with links to specific bond examples containing the provisions:
- Lack of Aggregate Liability Clause: An aggregate liability clause limits the Surety’s liability to the bond penalty regardless of the number of claims made against the bond. (LA Appraisal Management Company)
- Lack of Cancellation Clause: Provides the number of days the Surety must provide the Obligee notice for cancellation. Without a cancellation clause, the Surety is unable to terminate its future liability under the bond. (MA Motor Vehicle Glass Repair Shops & NY Utility Deposit Bond - Con Edison)
- Forfeiture Clause: This provision provides the Obligee the right to demand the entire bond penalty regardless of the size of actual loss. (DE Private School Bond)
- Adverse Selection: This occurs when an Obligee enforces a bond requirement for principals who do not meet certain standards (credit, net worth, experience, etc) of the Obligee. (FL Construction License Bond)
- Demand Clause: Language limiting the time the Surety has to respond (i.e., 10 to 15 days) does not allow sufficient time for the Surety to investigate an alleged default and choose the option that is in the best interest of all parties. (WA Street Use Bond)
- Discovery Period/Tail: The Obligee may establish a time period they have for making claims against the bond once cancelled. Generally, the longer the time frame, the greater the risk. (SC Residential Contractors License Bond)
- Stacking/Cumulative Liability: This occurs when a bond has a definite expiration date and a new bond must be filed for each successive term. Each bond carries a new bond penalty, thus “stacking” the bond liability each year. (MD Home Improvement Contractor License Bond)
- Per Occurrence Limits: This refers to a bond penalty that is applied on an occurrence basis. For example if the Surety received 10 claims of $5,000 each on a $10,000 per occurrence bond, they could pay out $50,000. This is seen most often on bonds in lieu of insurance. (VA Payment & Performance - State Water Control Board)
- Warranty Provisions: Some statutes will extend a Surety’s obligation to cover any warranties that the Principal is required to maintain. The warranty provision may extend for a long period of time increasing the Surety’s exposure. (WA Side Sewer Contractor - City of Redmond)
- Liability in Excess of Bond Penalty: Language that adds such covered amounts as court costs and attorney fees, in addition to the penal sum of the bond. (IN Blanket Right-of-Way Bond)
Bond forms are non-negotiable contractual obligations between three parties (Principal, Obligee & Surety) and dictate the agreement the Principal must adhere to. There are a wide variety of different bond types; however, most bonds follow a standard set of guidelines which help to form its underlying agreement. A majority of bonds have specific forms, but in some cases a generic forms created by the Surety may satisfy the requiring entity. Lastly, some bond forms contain clauses burdensome to the carrier and may require more stringent underwriting for a Surety to accept the risk. Surety professionals should understand these difficult clauses and how it may impact their ability to entertain certain risks.