The report is about concept of Surety Bonds in Project and Construction management

1. A Graduate Report on
Surety Bonds
For the Course of
‘Project Formulation and Appraisal (CE-636)’
of the M.Tech (I) Sem-2 of Urban Planning
Submitted by: Yajush G. Sonar (P17UP010)
Faculty Advisor: Dr. Dilip A. patel
P.G Section (Urban Planning),
Department of Civil Engineering,
सरदार वल्लभभाई रा�ीय �ौ�ोिगक� संस्थान, सूरत
Sardar Vallabhbhai National Institute of Technology
Surat, Gujarat
(2017-2018)

2. CERTIFICATE
This is to certify that a Graduate Report on “Surety Bonds” submitted by me has
satisfactorily completed the requirement for the Subject CE: 636 –Project Formulation and
Appraisal during the year 2017-18.
Yajush G. Sonar (P17UP010)
Faculty Advisor,
Dr. Dilip A. Patel
P.G Section (Urban Planning),
Department of Civil Engineering,
सरदार वल्लभभाई रा�ीय �ौ�ोिगक� संस्थान, सूरत
Sardar Vallabhbhai National Institute of Technology,
Surat, Gujarat
(2017-2018)

3. ACKNOWLEDGEMENT
I earnestly wish to express my heartfelt thanks and a sense of gratitude to Dr. Dilip A. Patel
for his valuable guidance and constant inspiration in preparing this report. I also acknowledge
the inspiration and encouragement provided by him. Frequent interactions with him in all
aspects of the report making have been a great learning experience. I shall always cherish his
support and encouragement.
YAJUSH G. SONAR

4. CONTENTS
1. Introduction
1.1. Introduction
1.2. Difference and Similarities in Surety bonds and Traditional Insurance
1.3. Types of Surety Bonds
2. Construction Surety Bonds
2.1. Overview
2.2. Need
2.3. Types of Contract/Construction Surety Bonds
2.4. Requirement of Construction surety bonds
2.5. Operation and working
References

5. CHAPTER 1
INTRODUCTION
1.1. Introduction:
A surety bond is defined as a contract among at least three parties:
• The Obligee: the party who is the recipient of an obligation.
• The Principal: the primary party who will perform the contractual obligation.
• The Surety: who assures the obligee that the principal can perform the task.
A surety bond is not an insurance policy. A surety bond is a guarantee, in which the surety
guarantees that the contractor, called the “principal” in the bond, will perform the
“obligation” stated in the bond. For example, the “obligation” stated in a bid bond is that the
principal will honour its bid; the “obligation” in a performance bond is that the principal will
complete the project; and the “obligation” in a payment bond is that the principal will
properly pay subcontractors and suppliers. Bonds frequently state, as a “condition,” that if the
principal fully performs the stated obligation, then the bond is void; otherwise the bond
remains in full force and effect.
1.2. Difference and Similarities in Surety bonds and Traditional Insurance:
Surety Bonds Insurance Policies
Regulated by State Insurance Department Regulated by State Insurance Department
Prequalification intended to prevent loss Spreads Fortuitous loses among large number
of similar risks
Three party- contractor and surety bear risk Two party- risk transfer to Insurer
Coverage is Project specific Coverage is Term specific and renewable
Bonds form can be statutory or may be
negotiated by owner or surety and contractor
Policy forms vary by Insurance company
Coverage- 100% of contract price for Coverage upto policy limit, less deductible

6. performance, 100% for payment upto the
penal sum of the bond
Claims- Surety has the right to contract
balance and indemnity from contractor for
costs associated for settling a claim
No right to insured assets, however
companies can subrogate against a third party
of another insurer
Bonds are required by law for public works
and voluntarily by private owners
Buying insurance is a voluntary way of
managing risk of loss for the insured
1.3. Types of Surety Bonds:
1. Contract/Construction Surety Bonds:
Contract bonds, used heavily in the construction industry by general contractors as a
part of construction law, are a guaranty from a Surety to a project's owner (Obligee)
that a general contractor (Principal) will adhere to the provisions of a contract.
Contract/Construction Surety bonds are further classified into Bid Bond, Performance Bond
and Payment Bond.
2. Commercial Surety Bonds:
Commercial bonds represent the broad range of bond types that do not fit the
classification of contract. They are generally divided into four sub-types: license and
permit, court, public official, and miscellaneous.
Similarly, Commercial surety bonds are further classified into License and permit bonds,
Court bonds, Public official bonds and Miscellaneous bonds.
Whereas, here Contract /Construction Bonds are in the scope and to be studied further.

7. CHAPTER 2
CONSTRUCTION SURETY BONDS
2.1. Overview:
A surety bond is a three-party contract comprised of the Surety, the Principal (contractor) and
the Obligee (owner). The Principal promises to perform in accordance to its contract
obligations. Surety bonds used in Construction are called Contract Surety Bonds.
Construction bond is a type of surety bond used by investors in construction projects to
protect against disruptions or financial loss due to a contractor's failure to complete the
project or to meet contract specifications.
2.2. Need:
A surety bond is there to ensure project completion within the terms of the contract. If a
contractor experiences cash flow problems, the Surety may assist the contractor. If the
contractor abandons the job, the Surety may replace the contractor.
Most surety companies are subs or divisions of insurance companies and both surety bonds
and insurance policies are regulated by state insurance departments. However, insurance
policies are designed to compensate against unforeseen adverse events. Surety bonds are
designed to guarantee the contractor’s contractual obligations. The Surety prequalifies the
contractor based on financial strength and construction expertise. The bond is underwritten
with little expectation of loss.
2.3. Types of Contract/Construction Surety Bonds:
A surety is the financial guarantor of a construction bond, guaranteeing the obligee that the
contractor will act in accordance with the terms established by the bond. Surety companies
will evaluate the financial merits of the principal builder and charge a premium according to

8. their calculated likelihood that an adverse event will occur. A surety can assist a contractor
having cash flow problems and may also replace a contractor who abandons a project. There
are three main types of construction bond provided by a surety,
1. Bid Bond:
• This bond is necessary to the competitive process bidding. Each contending
contractor has to submit a bid bond along with their bids to protect the project
owner in the event that a contractor backs out of the contract after winning the
bid or fails to provide a performance bid, which is required to start working on
the project.
• Provides financial protection to an obligee if a bidder is awarded a contract
pursuant to bid documents, but fails to sign the contract and provide required
performance and payment bonds. The bid bond process also helps to screen
out unqualified bidders and is necessary to the process of competitive bidding.
2. Performance Bond:
• A bid bond is replaced by a performance bond when a contractor accepts a bid
and proceeds to work on the project. The performance bond protects the owner
from financial loss if the contractor’s work is subpar, defective, and not in
accordance with the terms and conditions laid out in the agreed contract.
• Protects the owner from financial loss in the event the contractor fails to
perform the contract in accordance with its terms and conditions. If the
Obligee declares the Principal in default and terminates the contract, it can call
on the Surety to meet the Surety’s obligations under the bond.
3. Payment Bond:
• This bond, also called a labour and material payment bond, is a guarantee that
the winning contractor has the financial means to compensate his or her
workers, subcontractors, and suppliers of materials.
• Assures the contractor will pay certain workers, subcontractors and material
suppliers.
2.4. Requirement of Construction surety bonds:

9. 1. Public Sector - Statutory Requirement:
a) Federal Government- Protects taxpayer dollars; assures that lowest bidder is
capable of completing the project.
b) State and Local Governments- Necessary payment protection for
subcontractors and suppliers.
2. Private Sector - Discretionary Owner Requirement:
a) Private Owners- Surety assures qualified contractor; provides expertise,
experience and assistance; in event of contractor failure surety handles and
completes the project.
b) Lending Institutions- Surety assures project will be built according to terms
and conditions of the contract; lender can be dual obligee with direct rights
under the bond.
c) General Contractors- May require bonds from their subcontractors.
2.5. Operation and working:
When a contractor vies for a construction job, he is usually required to put up a contract bond
or construction bond. The construction bond provides assurance to the project owner that the
contractor will perform according to the terms stated in the agreement. On larger projects,
construction bonds may come in two parts - one to protect against overall job incompletion
and another to protect against non-payment of materials from suppliers and labour from
subcontractors.
There are generally three parties involved in a construction bond –the investor/project
owners, the party or parties building the project, and the surety company that backs the bond.
The project owner or investor, also known as the obligee, is typically a government agency
that lists a contractual job that it wants done. To reduce the likelihood of a financial loss, the
obligee requires that all contractors put up a bond. The contractor selected for the job is
usually the one with the lowest bid price since investors want to pay the lowest amount
possible for any contract.

10. By submitting a construction bond, a principal, that is the party managing the construction
work, is stating that he can complete the job according to the contractual policy. The
principal provides financial and quality assurance to the obligee that not only does he have
the financial means to manage the project but that the construction will be carried out to the
highest quality specified. The contractor purchases a construction bond from a surety which
runs extensive background and financial checks on a contractor before approving a bond.
If the principal fails to perform the obligation stated in the bond, both the principal and the
surety are liable on the bond, and their liability is “joint and several.” That is, either the
principal or surety or both may be sued on the bond, and the entire liability may be collected
from either the principal or the surety. The amount in which a bond is issued is the “penal
sum,” or the “penalty amount,” of the bond. Except in a very limited set of circumstances, the
penal sum or penalty amount is the upward limit of liability on the bond.
The person or firm to whom the principal and surety owe their obligation is called the
“obligee.” On bid bonds, performance bonds, and payment bonds, the obligee is usually the
owner. Where a subcontractor furnishes a bond, however, the obligee may be the owner or
the general contractor or both. The people or firms who are entitled to sue on a bond,
sometimes called “beneficiaries” of the bond, are usually defined in the language of the bond
or in those state and federal statutes that require bonds on public projects.
Through a surety bond, the surety agrees to uphold—for the benefit of the obligee—the
contractual promises (obligations) made by the principal if the principal fails to uphold its
promises to the obligee. The contract is formed so as to induce the obligee to contract with
the principal, i.e., to demonstrate the credibility of the principal and guarantee performance
and completion per the terms of the agreement.
The principal will pay a premium (usually annually) in exchange for the bonding company's
financial strength to extend surety credit. In the event of a claim, the surety will investigate it.
If it turns out to be a valid claim, the surety will pay and then turn to the principal for
reimbursement of the amount paid on the claim and any legal fees incurred. In some cases,
the principal has a cause of action against another party for the principal's loss, and the surety
will have a right of subrogation "step into the shoes of" the principal and recover damages to
make up for the payment to the principal.

11. If the principal defaults and the surety turns out to be insolvent, the purpose of the bond is
rendered nugatory. Thus, the surety on a bond is usually an insurance company whose
solvency is verified by private audit, governmental regulation, or both.
A key term in nearly every surety bond is the penal sum. This is a specified amount of money
which is the maximum amount that the surety will be required to pay in the event of the
principal's default. This allows the surety to assess the risk involved in giving the bond; the
premium charged is determined accordingly.

12. REFERENCES
Bibliography
[1] Zurich ,"Contract Surety Bonds", Zurich, August 13, 2012
[2] Dan Donohue and George Thomas, “Construction Surety Bonds In Plain English”, 1996
[3] Alice Zelikson, GenRe (A Berkshire Hathaway Company) Article, Mar 19, 2015
Webliography:
www.wikipedia.com
www.investopedia.com