Identifying Clients Who Need Surety Bonds

Commercial insurance agents have numerous existing clients who are required to purchase surety bonds. It can be challenging to figure out which insureds need to purchase bonds and when. There are three main types of surety bonds: commercial, contract, and court bonds. Understanding each of the three types will allow for easier identification of insureds that also need to purchase surety bonds.

Commercial Bonds

Commercial surety bonds, also referred to as “license and permit bonds”, are most often required when a business applies for a business license and must be renewed each year for the life of the business. Businesses that are required to have this subtype are:

  • Appraisal Management Companies
  • Auctioneers
  • Bars, Restaurants, and Any Business With Alcohol Sales
  • Cannabis Related Businesses
  • Car Wash Owners
  • Cleaning Services
  • Contractors
  • Convenience Stores Who Sell Lottery Tickets
  • Driver Training Schools
  • Health Clubs
  • Home Health Care Providers
  • Immigration Consultants
  • Mobile Home Manufacturers
  • Mortgage Brokers
  • Motor Vehicle Dealerships
  • Notaries
  • Pharmaceutical and Medical Equipment Businesses
  • Public Officials
  • Realtors
  • Retailers of Tobacco Products
  • Telemarketing or Fund Raisers
  • Travel Agents
  • Truckers and Other Transportation Related Businesses
  • Unaccredited Schools or Colleges

Contract Bonds

Contract bonds tend to have the highest premiums and are needed by contractors, though not all contractors need contract bonds. Contractors may need to purchase a commercial bond for their business license or a permit to operate in a specific city or county. They will also need to purchase bid bonds, performance and payment bonds, labor and materials bonds, warranty bonds, maintenance bonds and developer bonds.

Public and private construction projects are the two general project types for contractors. Public jobs, such as renovations to a school or a contract with the city to maintain roads or salt sidewalks, require a bid bond and performance and payment bond to be purchased for public over a certain amount. Each city, county, state, and federal government entity can require a bond for any size project if they choose too. The same applies with private work. If an owner of a retail store wants a new location to be constructed, they can choose to require any contractors who wish to bid on the project to be bonded.

Court Bonds

The last and least common type of bond is a court bond. Court bonds are required by a court. A court may require executors of wills and trusts to obtain a surety bond to ensure that the trust or will is executed as the benefactor intended it to be. Pennsylvania for example, has a requirement that any executors who reside in a different state than the benefactor must obtain a probate bond before being granted approval to execute a will. Court appointed guardians must obtain a probate bond in order to have control over a minor or incapable person’s well-being and their assets. Public officials such as a local treasurer must obtain a type of court bond in order to sign checks on behalf of the city. Different states, cities, and industries have varying types of bonding requirements. If an agency is in California, their clients may need numerous bonds of all types. If an agency is located in a less populated state such as Missouri, they may not need as many commercial bonds as they do contract bonds. States located in the northeast that are clustered together may require more probate bonds than larger states in the Midwest. Becoming appointed with a broker such as AAU will enable an agency to have access to surety insight that can be used to penetrate their existing book of commercial insurance with surety bonds.

The Three Types of Surety Bonds

There are three main types of surety bonds; commercial, contract, and court bonds. Within each of the three types, there are numerous subcategories. The following will provide a general overview of the three main types. All surety bonds are three-party agreements between a principal, obligee, and surety company. However, the purpose as to why these bonds are required varies between bond types.

Commercial Bonds

Local, state, and federal government agencies require commercial bonds for businesses in certain industries. Commercial bonds are required to be purchased before the business can legally be licensed. These bonds are also referred to as “license and permit bonds”. The bonds require that business owners abide by laws and regulations enforced to ensure consumers are not harmed by the business owner’s unlawful acts. These bonds also ensure that the bills and fees will be paid on time, such as utility bills, taxes, employee wages, etc.

Examples of commercial bonds are motor vehicle dealership bonds, freight broker bonds (BMC 84), DMEPOS (Durable Medical Equipment, Prosthetics, Orthotics, and Supplies), notary bonds, contractor license bonds, and marijuana bonds

Court Bonds

There are two subcategories of court bonds- judicial/civil and probate/fiduciary. Judicial/Civil court bonds are required when a court proceeding informs certain parties they must get a specific bond in order to verify their financial and personal integrity. A judicial court bond denies all uncertainties within court proceedings which would lead to losses resulted from a ruling. Fiduciary or probate bonds are required for an individual that is appointed to care for someone else that is either a minor or incompetent to care for themselves. These individuals are appointed by the court to handle assets and the care of a person who cannot do so themselves.

Examples of judicial court bonds are appeal bonds and the plaintiff’s attachment bonds. Examples of fiduciary or probate bonds include guardianship bonds, custodian bonds, executor bonds, and VA bonds.

Contract Bonds

Contract bonds guarantee that only qualified contractors or sub-contractors are able to bid and perform work on construction projects. The Obligee is typically a construction project owner that can be a government entity for public projects or a private property owner.

Examples of contract bonds are bid bonds, payment bonds, performance bonds, and supply bonds.

Force Majeure and Contract Bond Claims Due to COVID-19 Impacts

Impacts stemming from COVID-19 are felt in every aspect of life. The surety industry is no different. Different types of surety bonds will be affected in different ways. Understanding the indirect effects of how COVID-19 affects the contract surety industry can help surety carriers, surety producers, and contractors mitigate risks and soften the blow.

Numerous articles have popped up outlining how Force Majeure clauses may be utilized for project delays leading to potential surety claims related to the COVID-19 pandemic. Force Majeure is a contract clause that excuses the performance of a construction contract due to uncontrollable events. Not all construction contracts will contain a Force Majeure clause covering COVID-19 or viruses. The most common performance and payment bond form from the American Institute of Architects outlines delays and extensions of time in their Performance and Payment bond form (AIA Document A201-2007) in Article 8, section 3.1.

Force Majeure is not a “cure-all” that sureties and contractors can rely on to keep from being responsible for bond claims resulting from completion date delays due to COVID-19 impacts. Force Majeure clauses may not exist in all performance and payment bond form language. It’s also possible that contract amendments removing force majeure clauses may have been removed if mutually agreed upon prior to signing a contract. There’s also Burden of Proof that comes into play where it must be proven that is impacts from COVID-19 have made completing the project impossible, not impractical or unprofitable.

Alternative Solutions Outside of Force Majeure

There are several options beyond Force Majeure. First, open communication between all parties, including the project owner, general contractor, suppliers, vendors, subcontractors, and sureties is essential. Always consider renegotiations and change orders when it comes to the initial parties involved. Next, there is the Good Faith Attempt to Perform and other regulations that can be used, below:

  • The Doctrine of Impossibility/Impracticability – 30 Williston on Contracts § 77:31 (4th ed.) that states:

“A contracting party has no duty to perform an obligation in the agreement if performance is rendered impossible or impracticable, through no fault of its own, because of a fact that existed at the time when a contract was made and about which this party neither knew nor had reason to know, and the nonexistence of which was a basic assumption of the parties’ agreement.”

  • Default under Federal Contracts – FAR § 52.249‐10‐ Default that reads:

“(b) The Contractor’s right to proceed shall not be terminated nor the Contractor charged with damages under this clause, if ‐ (1) The delay in completing the work arises from unforeseeable causes beyond the control and without the fault or negligence of the Contractor. Examples of such causes include (i) acts of God or of the public enemy, (ii) acts of the Government in either its sovereign or contractual capacity, (iii) acts of another Contractor in the performance of a contract with the Government, (iv) fires, (v) floods, (vi) epidemics, (vii) quarantine restrictions, (viii) strikes, (ix) freight embargoes, (x) unusually severe weather, or (xi) delays of subcontractors or suppliers at any tier arising from unforeseeable causes beyond the control and without the fault or negligence of both the Contractor and the subcontractors or suppliers; and…”

  • Excusable delays involving federal contracts – FAR § 52.249‐14 states:

(a) Except for defaults of subcontractors at any tier, the Contractor shall not be in default because of any failure to perform this contract under its terms if the failure arises from causes beyond the control and without the fault or negligence of the Contractor. Examples of these causes are (1) acts of God or of the public enemy, (2) acts of the Government in either its sovereign or contractual capacity, (3) fires, (4) floods, (5) epidemics, (6) quarantine restrictions, (7) strikes, (8) freight embargoes, and (9) unusually severe weather. In each instance, the failure to perform must be beyond the control and without the fault or negligence of the Contractor. Default includes failure to make progress in the work so as to endanger performance….”

Construction is currently considered an essential business by the majority of states, as this industry is a driving force in the economic health of our country. This does not apply to all states and local jurisdictions, and may change from day to day. Construction is even considered an exemption under the California Executive Order N-33-20. Being deemed an essential business exempt from executive stay-at-home orders does not shield the construction industry from the impacts of COVID-19. If a bonded project comes to a halt, sureties may face claims due to delayed completion of projects. Now is the time to be proactive and have those difficult conversations.