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What is a Surety Bond?
A Surety Bond is a financial guarantee between parties of a contract, with the aim to deliver pre-obligated conditions stipulated under at the agreement at a future date. The obligee (tender party that awards the contract) would want some assurance that the principal (contracted party) would be able to complete the project in time, hence they would require the principal to secure a Surety Bond from the Surety (in this case an insurance company) as protection. In any event that the principal fails to meet conditions stated in the contract, the obligee is entitled to claim damages from the Surety for losses associated with performance failure on the part of the principal.
Surety bonds are commonly used as an alternative to bank guarantees, provided the obligee is acceptable to its use. Securing a bank guarantee typically requires the principal to pledge collaterals such as stocks, time deposits, cash and/or personal or corporate director’s guarantees in exchange for its issuance. Cash collaterals are often dollar for dollar for the bank guarantee value, meaning to raise a bank guarantee for $500,000, the principal would have to pledge a cash deposit of an equivalent $500,000 with the bank. Premiums charged for a surety bond is a fraction of the bond value, hence businesses often turn to the insurance market for solutions in order to fulfil the project requirement.
How does a Surety Bond work?
A surety bond is a financial guarantee that binds the principal to deliver agreed conditions in the specified underlying contract to the obligee. In any case that the principals fails to deliver the terms of the contract, the obligee is entitled to submit claims to the principal to recover losses capped to the bond limit.
Surety Bonds involve 3 parties: the Obligee, the Principal, and the Surety. These terms are explained below:
1. Obligee (the client)
The obligee is the party that requires a surety bond as protection, and they can be corporates, government agencies or individuals. The prerequisite for surety bond is to cover financial damages in the case of a claim, usually in situations whereby the Principal is unable to fulfil its obligations under the contract
2. Principal (the contractor)
The principal is the party that the obligee requires to take out a surety bond. The surety bond will protect the obligee against any breaches in contract or unethical business practices on behalf of the principal. The principal of a surety bond is typically a business that’s trying to obtain a license from a government agency or bid on a contract.
3. Surety (the insurance company)
The surety is the insurance company that backs the surety bond up to the full bonded amount. The surety provides the financial guarantee to the obligee that the principal will fulfill their obligations outlined in a contract agreement by paying a preagreed premium amount for the coverage
What are the different types of Surety Bonds available?
Project owners can utilise a wide variety of different bond types to protect themselves. The key types of Surety Bonds available are:
- Bid or tender bond: Clients will sometimes require contractors to submit bid/tender bonds during the tender process. The bid/tender bond ensures that the contractor who is awarded the project will undertake the contract based on the terms agreed. Click here for bid/tender bond quotes..
- Performance bond: This is also referred to as a “Contract Bond”. Performance Bonds help to guarantee that the contractor meets their contractual obligations to the client by performing satisfactory work. If the contractual requirements are not met, the bond will help to compensate the client for losses. Click here for Performance Bond quotes.
- Retention bond: After a project is completed, clients typically hold onto a “retention amount” (usually between 5-10% of the contract value) to ensure that the contractor performs any required defects repair works. A retention bond replaces this retention amount, allowing contractors to free up cash flow. Click here for Retention Bond quotes.
- Payment bond: This is a type of bond that is used to guarantee that subcontractors and suppliers (who are working for the main contractor) are paid for the work and material they supply. This prevents project delays or shoddy work being done due to the main contractor delaying or refusing payment to their own sub-contractors. Click here for Payment Bond quotes. Click here for Payment Bond quotes.
- Advance payment bond: Your contractor or supplier may request for a downpayment to begin work. This bond protects your down-payment. In the event that your contractor or supplier cannot start work, goes bankrupt, or disappears, this bond will compensate you for your deposit. Click here for Advance Payment Bond quotes.
- Maintenance bond: This bond protects the project owner in case any defects arise in the completed work. Such defects could be caused by poor workmanship, poor design, or substandard materials used. Click here for Maintenance Bond quotes.
- Foreign Worker Security bond: This bond is required by MOM for all foreign workers. It ensures that employers abide by the regulations for employing foreigners. Click here for Foreign Worker Bond quotes.
- Employment Agency bond: This bond is required by MOM for all Employment Agencies. It ensures that Employment Agencies abide by the licensing requirements set out by the law. Click here for Employment Agency Bond quotes.
Do I need a Surety Bond?
Surety bonds are purchased mostly due to the requirements under the project tendering process. Upon the contract being awarded, the principal is required to have a Surety Bond that covers the Project bond value as stipulated under the contract. The bond value is usually 10-15% of the total project value.
There may be instances whereby the obligee cannot accept a Surety Bond, but instead asks for a Bank Guarantee. In such a case, the principal would have to put up a higher value security in exchange for a bank guarantee. A surety bond which is acceptable to the obligee would usually be a cheaper option as the premium charged is a fraction of the project cost, and monies which would otherwise be put up as collateral in exchange for a bank guarantee can be used as working capital for the project.
- Construction & other businesses with government-issued licenses
- Construction companies with government projects over $100k
- General contractors who are bidding on new projects
- Businesses in high-risk or high-tax sectors, such as alcohol and tobacco
- Businesses that need to insure customer property, such as auctioneers
- Companies that want to protect themselves against employee theft
- Companies that expect to face litigation in the near future
How much does a Surety Bond cost?
First off, the price of a Surety Bond depends on the exact type of bond you’re looking for. For instance, Performance Bonds (one of the most popular types of Surety Bonds), start from about 1% of the required bond amount. Employment Agency Bonds also start from about 1% of the required bond amount.
Each Surety Bond is underwritten based a variety of key factors: your company’s financial strength, your obligee’s (i.e. client) financial strength, your company’s directors, and whether you’ve filed any bond claims before.
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