Surety bond: A collateral bond is a lawful contract that guarantees that your duty or a set of duties are fulfilled.
In legal terms, duty is a promise that can be legally enforced.
All of the duties or responsibilities which one party must perform must be specified in writing when a bond is furnished.
The common misunderstanding is that an insurance bond is synonymous with insurance. This is not. It is not.
Whereas insurance companies are the primary issuers of a securities bond and are mechanisms for risk transfers, a securities bond does not correspond to a policy for insurance.
First of all, there are three parties to the security bond: the Principal, Obligee, and Surety.
Insurance only has one source of capital that protects it from a loss, whereas a collateral bond has two sources of funds:
- The properties of the principal
- The credit risk premium paid
The three people involved in a Surety bond
The principal is the person buying the bond and the person required to meet the bond requirements.
Before a guarantee bond is issued, credentials of the principal will be evaluated.
The obligee is, by comparison, the group that needs the principal’s security bond.
The bondholder shall specify the terms of the bond that, in most cases, are derived from a law, statute or order.
When the principal does not perform the required duties, the creditor shall be entitled to claim the securities bond for the purpose of recovering the outcome of the business loss.
The surety is the party that is to be the backing of the principal. The assurance guarantees that the principal works faithfully.
However, if the principal refuses to meet the obligations of the pledge, the guarantee is forced to go through the principal’s shot to finish the deal, which means that the guarantee is accountable to the principal for the consequences.
Requirements for granting a surety bond
The three Cs of the underwriting are also known.
The Chartered Property Casualty Underwriter (CPCU) is an expert in the matter of property-victim insurance, according to the site of the Surety Bond Authority.
Before a bond is released, the contractor must analyze the three C’s thoroughly.
Is the principal honest? Is the head an integrity person? Will he perform his obligation regardless of what happens?
These are just a few things that a contractor will examine when evaluating the character of a principal.
Some people might misperceive that the person’s financial strength is not as important when it comes to the company.
Character actually plays a leading role in literature.
History shows that downplaying character for financial potential has led to many losses in defense.
The crash of Enron back in 2001 was a major example of this.
The protection bond industry was unable to safeguard its loan exposure to Enron by ignoring the value of character.
The sector has now suffered a heavy blow by paying billions of dollars.
The ability to fulfill the obligations and to maintain the resources in order to complete those duties is a skill of the principal.
In order to complete the job, the principal needs established and secured intellectual property.
Capacity is measured by several factors. The following are:
- The principal’s experience
- Specialist know-how
- Facilities for business
- Management of workers
- The competitiveness of the industry
- Credit history of the principal
The principal will have enough money to finish the project successfully or to carry out the contractual tasks in full.
The financial strength of the principal is relevant to the credit risk level. In general , the greater the credit risk, the greater the bond penalty.
Furthermore, the obligation length will also be taken into account.
The contractor shall require the principal, amongst others, to make the latest financial statements in order to assess the capital of the principal.
A certified public accountant may have to file corporate financial statements and at least have to cover the last three financial years.
How long does it take for the Surety bond to be processed.
It depends on the type of security bond and the time it is submitted to the principal.
The turnaround time for most bonds, however, is not that long. In reality, in just 1-3 days you will obtain your bond.
Bonds with higher risks would need more than the aforementioned days.
Riskier bonds undergo a more complex process of bonding which leads to longer turnaround times.