CAIB 3 Chapter 5: Surety

Question	Answer
Definition of Surety	State of being sure, certain and secure.
Definition of Suretyship	"Guarantee of performance" made by one person or entity for another.
Two main classes of bonds issued by surety companies.	1. Fidelity Bond- Employers request this bond to ensure that they would be protected for the dishonest acts of employees. 2. Surety Bond- Undertaking by one party (the surety) to become accountable to another party (the oblige) for the performance of an obligation or undertaking by a third party (the principal). Promise to provide credit if and when needed.
The 3 C's: Form the Basis of Credit Appraisal	1. Character 2. Capacity 3. Capital
1. Character:	Review of the company's management performance. Surety must ensure the principal is of good character, pays bills promptly and is of good reputation.
2. Capacity:	Involves an assessment of the principals ability based on past history. Need to be satisfied that principal has the knowledge, experience, and labor pool necessary to do the job.
3. Capital:	Financial capability of the principal to complete the work on hand , in addition to the project for which bonding is requested, forms the basis of the capital assessment. When large amounts involved, the financial resources constitute the most important factor in determining whether the principal can obtain a surety guarantee.
Benefit of Suretyship:	For the Principal- Added confidence; gained from the fact that the surety is satisfied in their ability to carry out the required task. For the Obligee- Provides them with the confidence needed to undertake various projects.
Three Parties to any Surety Agreement:	1. Principal-Person primarily liable. 2. Obligee-The party to whom someone else is obligated under a contract. 3. Surety-One who undertakes to pay money or to do any other act in an event that the principal fails therein.
Two Methods Available to the Surety to Collect Amounts Owed:	1. Assignment to surety of obligee's rights 2. Right of subrogation- subject to the bond limit or penalty of the bond.
Eight Characteristics of Surety Bonds:	1. Three Party Contract 2. Principal Liable to the Surety 3. No Losses Expected 4. Indetermindate Length and Non Cancellable 5.Statutory or Non Statutory in Form 6. Bond Limit (Penalty) 7. Bond Premium 8. Written Contract
1. Three Party Contract	Three parties to any surety agreement: 1) Principal- person primarily liable 2) Obligee- the party to whom someone else is obligated under a contract 3) Surety- one who undertakes to pay money or to do any other act in event that the principal falls therein
2. Principal Liable to the Surety	Three important characteristics of the guarantee made by the surety: 1) Is a promise made to the obligee and not the principal 2) is a secondary obligation arising only on the default of the principal 3) Surety's duty to pay arises immediately upon default of the principal
3. No Losses Expected:	Prequalification of bond applicants strives to ensure that only those principals capable of performing their obligations be extended credit provided by the bond.
4. Indeterminate Length and Non Cancellable:	Some types of surety bonds are non-cancellable and terminate only when the principal's obligations have been fulfilled. Ex: settlement of a large estate may take many years : it is important that the bond be non cancellable and terminate only with the courts acknowledgment that all duties have been properly discharged.
5. Statutory or Non Statutory in Form:	-Stauatory- required by a municipal ordinance, or federal/provincial regulation/statute. Obligations of the parties ate a matter of law. -Non-statuatory- not required by law but flow from the contract or agreement between parties.
6. Bond Limit (Penalty):	Reflects amount of credit given to the principal. Represents amount of the penalty which the surety is prepared to pay in the event of default. Remains unchanged throughout period of contract and does not reduce.
7. Bond Premium:	Misnomer. Does not contemplate losses occurring, the sum charged for pre-qualification and other company expenses is more appropriately described as a "service fee" than premium.
8. Written Contract:	8. Surety contract must be provided in writing and executed under seal of the surety and principal. Oral contracts are not binding on the surety
Four Categories of Surety Bonds:	1. Contract Bond 2. Judicial Bond 3.License and Permit Bond 4. Miscellaneous Bond
Contract Bond:	Guarantees the fulfillment of certain obligations required under public and private contracts.
Supply Bond:	Agreement to furnish and deliver materials or supplies at agree price.
Contract Bonds used in Construction Agency:	-Supply Bond -Bid Bond -Performance Bond -Labour and Material Payment - Maintenance
Three Groups Capable of Designing Their Own Bond Wordings:	- Hydro/ Oil Companies -Crown Corporations -Municipalities
Three Risks Owners Face When Undertaking a Project Without Protection of Bonds:	1. Refusal/inability of the successful bidder to enter into a contract. 2. Failure of the contractor to complete the project at the contract price. 3. Inability of the contractor to pay subcontractors and suppliers.
Five Factors to be Considered by the General Contractor:	1. Terms of the contract 2. Relationship between the contractor and subtrade 3. Value of the subcontract. 4. Subtrades price in relation to other bidders 5. Whether the general contractor wishes to pay the cost of the bonds, rather than assume the risks associated with not doing so.
1. Terms of the Contract:	Owner may require all subtrades be bonded. In other instances, only subtrades doing work in excess of certain amounts may need to provide bonds.
2. Relationship Between the Contractor and Subtrade:	If the general contractor has every assurance that the work will be done, the requirement for a bond may be waived. This assurance may be based on past working relationship between the parties or on the reputation of the subtrade.
3. Value of the Subcontract:	When the amount of contract is relatively small, general contractor will weigh the benefits of requesting a bond against the amount at risk to it should the work not be completed. Some general contractors have a formal policy requiring performance bonds from subtrades when the value of work exceeds a predetermined amount. Amount varies between trades.
4. Subtrades Price in Relation to Other Bidders:	If the bid is competitive and not significantly below that of others, the general contractor may be satisfied that the subtrade will not experience financial difficulties that could result in default.
5. Whether the General Contractor Wishes to Pay the Cost of the Bonds, Rather than Assume the Risks Associated with not Doing So.	When subtrades are not bonded, the general contractor must determine the potential for default. If such potential exists, the general contractor may choose to pay for the bond required of the subtrade rather than allow work to commence without it.
Three Methods of Tender Deposits Acceptable:	1. Bid Bond- furnished to the owner (obligee) of a project and not in force until tender accepted 2. Certified Cheque- generally not recommended as it ties up the contractors working capital, time limits for accepting tenders and making claims do not apply, 3. Surety's Consent- issued in addition to or in place of bid bonds. Prepared like a letter and executed under seal. These letters assure that if the principal is the successful bidder, surety will issue such other bonds as are specified to ensure performance of contract.
Two Things that Project Owners Are Assured when Tender Deposit is in Form of Bid Bond:	1. The Principal has been prequalified to bid on the project. 2. The principal is bidding in good faith
Two Guarantees of the Bid Bond to the Project Owner:	1. Enter into a contract to perform the work at the tendered price. 2. Provide whatever security is specified to ensure performance of the contract.
Causes for Involuntary Default:	- Insolvency - Incompetence - Banks refusal to grant additional extension of credit. - Failure of major sub-contractors when no bonding is in place. - Delays resulting from: modifications to the contract, failure to receive materials/ equipment when needed, bad weather, labor disputes.
Causes for Voluntary Default:	- Improper estimate of the contract costs. - cash flow problems.
Two Options Available to the Surety if they are Satisfied the Contractor is in Position of Default:	1. Compensate the owner for delay and additional cost should the project need to be re-tendered. 2. Pay the difference between defaulting contractors bid and the amount for which the work is subsequently contracted.
Guarantee of the Labour and Material Bond:	Guarantees that the subtrades and suppliers will be paid for the work and materials that enter into the project.
Three Important Business Functions From the Guarantee of Labour and Material Bonds:	1. Reducing cost of construction. 2. Eliminates/ reduces delays in construction. 3. Frees up credit.
Reasons why Surety Companies may be Reluctant to Issue a Maintenance Bond:	-The longer the guarantee, the greater the chance for defects to become apparent. -Determining the cause of any defects becomes more difficult as time passes. -Judgements awarded by the courts have tended to increase the vulnerability of contractors to claims.
Information required to Supplement the 3 C's (Character, Capacity, Capital):	1. Financial Strength of Owners 2. Corporate Structure 3. Key Personnel Resumes 4. Banking Information 5. Accounting Information 6. Insurance Carried 7. Receivables and Payables
1. Financial Strength of Owners:	Statements of shareholders of the firm required. Such persons required to sign indemnities committing to indemnify the surety for any monies expended on behalf of contractor. Ensure sufficient reserves to honor indemnity .
2. Corporate Structure:	Prefer to deal with incorporated entities rather than partnerships or proprietorships.
3. Key Personnel Resumes:	Should clearly show the qualifications, special training and work history of the key personnel within the firm. Should detail size and type of project worked on.
4. Banking Information:	Letter of Reference required, defining the relationship the contractor has with the bank and how line of credit was established. A letter authorizing the bank to release information to the surety company
5. Accounting Information	5. Financial statements must be provided, prepared by an independent accountant w/ review engagement. Complete financial statement will include a balance sheet, profit and loss (income) statement, statement of changes in financial position and notes/supporting schedules explaining the major items in balance sheet and the way income is reported.
6. Insurance Carried	Surety will want to know what insurance is in place, the amount of coverage, and liability limits. Adequate insurance is essential.
7. Recievable and Payables:	Surety will require a list of accounts receivable and payable. Recievable not yet 100% current are normally discounted. Credit reporting agencies are frequently asked to report on the contractors payment habits. If payment record is poor, it can be interpreted as disorganization or poor credit risk.
Three Main Items of Interest to Set a Contractor's Bond Limits:	1. Working capital 2. Net Worth 3. Profitability
Working Capital:	Represents the amount of funds available to pay continuing business operating expenses until payment is received for work being undertaken by the contractor. Determined by subtracting current liability from current assets. Formula (WC=CA-CL)
Net Worth:	Calculated by establishing the amount of money remaining after all assets have been liquidated and all liabilities cleared.
3. Profitability:	Analysis of working capital and net worth. Consistent lack of profitability will normally mean a reduction in both the working capital and net worth position of the company. Contractor may attempt to improve the picture by adding other assets to the company.
Three Factors Affecting Working Capital:	1. Labor/ material ratio 2. Subcontracts 3. Customer paying habits
Fixed Assets:	-
Liquid Assets:	-
Two Accounting Methods Used to Report Income Earned:	1. Completed contract method 2. Percentage of completion method
Seven Pieces of Information Shown on Work in Progress Report:	1. Must carry same date as financial statements 2. Contract description/ location 3. Contract amount 4. Percentage completed to date 5. Percentage completed to date amount billed to date 6. Estimated cost to complete 7. Estimated date of completion
Four Forms of "Backup" Surety Company may Require for the Contractor:	1. Indemnity agreement 2. Third-party indemnity 3. Collateral security 4. Subordination agreement
1. Indemnity Agreement:	-When a bond application is signed by an individual or partnership, each partnership is fully obligated. In the case of a corporation, its assets are pledged and it may be necessary to obtain the personal indemnities of some. Allows the surety a right of action for all losses incurred byt it in investigating, adjusting and settling a claim against defaulting contractor.
2. Third Party Indemnity:	When the contractor lacks financial strength, outside indemnitors, are occasionally used to support the application. The third party is required to make good for any claims the contractor cannot pay. As contractor gains strength and is able to secure a bond of its own, third parties can be released.
3. Collateral Security:	Collateral can take form of cash or letter of credit. Surety will use this to protect itself against a loss, should the contractor be unable to reimburse in the event of a claim. can be provided by the shareholders or by third parties. Collateral is not favored by sureties as it ties up capital which may be needed later to complete the contract.
4. Subordination Agreement:	"Postponement Agreement"; provide the surety with the guarantee that shareholders loans to the company will remain in place until the surety allows them to be paid out. Intent is to ensure that all bills are paid before shareholder is paid. If contractor removes or disperses funds without surety's consent, surety is entitled to sue if a loss occurs.
Six Factors to be Considered before Issuing a Bond Request:	1. Nature of the work 2. Project location 3. Bond limits 4. Completion date 5. Conditions 6. Communications
1. Nature of the Work:	Surety is more likely to provide a bond if work being contemplated falls within contractors range of expertise in terms of size and type of work performed.
2. Project Location:	Location may increase potential for default.
3. Bond Limits Required:	Concern about the impact the proposed contract will have on existing work. Will want to ensure the limits it approves are not in excess of the credit established.
4. Completion Date:	When contractor has more than one long term project underway, the surety will be cautious in extending credit to other projects.
5. Conditions:	Special contract conditions can affect the ability of the contractor to successfully perform the contract. Important to ensure that payments are made by the owner on a regular basis for work and materials supplied by contractor.
6. Communications:	Past ability of the contractor to accurately predict job cots/profits will influence the decision of the underwriter. If contractor has consistently demonstrated ability to produce the kinds of results it projects, the underwriter has one less reason to doubt the performance of the contract. Surety underwriter may also be interested in the contractor to provide monthly statements in order to provide assurance of costs and thus being able to spot problems areas before they get out of control.
Licensing Requirements Provides Governments with:	- source of revenue -means of regulating the activities of license holders
Compliance Guarantee:	Basic guarantee that principals will comply with those laws that affect them.
Financial Guarantee:	Usually require surety company to protect the government body that granted license/permit against monetary damage resulting from failure of licenses to comply.
Idemnity Guarantee:	Extends the provisions contained in Financial Guarantees to third parties sustaining financial damages. Third parties are able to claim directly when failure to compliance. Usually required of those who must obtain permits from public bodies before commencing activity.
Good Faith Guarantee:	Some license and permit bonds guarantee that principals will perform in good faith.
Credit Guarantee:	Bonds providing credit guarantee are normally required of principals who sell property of others. Guarantee that principals will conduct business affairs in accordance with the best interest of their creditors and provide an honest accounting of funds in possession.
Three Common Characteristics of all License and Permit Bonds:	1. Bond limit or penalty determined by stature or other regulation and is usually quite low. 2. Cover all statutory or other regulatory obligations of the principal and these details are not required to be described in the bond. 3. Term of the bond generally coincides with the term of the license or permit.
Two Broad Classes of Bonds that May be Required by Probate Court or Court of Equity:	1. Court Bonds 2. Fiduciary Bonds
1. Court Bonds:	Bonds required in matters of litigation. 1. Plaintiff's and Defendants Bonds 2. Attachment Bond 3. Release of Attachment Bond 4. Injunction Bond 5. Appeal Bond
2. Fiduciary Bonds:	Persons appointed by the courts to serve as administrators, guardians, and trustees are deemed "fiduciaries". Duties essentially involve managing, controlling of disposing of the property of others. Such persons are officers of the court appointed to handle the legal duties. Laws governing the responsibilities are exacting and the law requires the fiduciary be bonded for the faithful performance of the duties prescribed. When trust is breached, the principal and the surety must make god any deficiency. Three main classes of bonds: 1. Administrators and Executors 2. Guardians and Committees 3. Trustees in Bankruptcy
Plaintiff and Defendant Bonds:	Plaintiff's and Defendants Bonds- When a person commences action against another to obtain a type of equitable remedy as opposed to money damages, a court may require this bond be filed with it. In the even a plaintiff's action should fail, the bond guarantees the defendant (obligee) that the plaintiff (principal) will pay any damages including court costs.
Attachment Bond:	Plaintiff must give court this bond before they will attach or take property by legal authority.
Injunction Bond:	Can be obtained from the court to ensure that the defendant in an action performs or refrains from performing some act or function.
Appeal Bond:	Required of a plaintiff who did not obtain the remedy that was sought and desires to appeal to a higher court. Guarantees the payment of all court costs on appeal.
Administrators and Executors Bond:	Most common. Guarantees faithful performance of the admin, according to law, of a deceased persons estate.
Guardian and Committee Bond:	Someone nominated by a will and subsequently appointed by the court to manage affairs of a minor.
Trustees in Bankruptcy Bond:	Trustee is appointed by court to liquidate all assets and divide remaining proceeds amongst the creditors. Requires specialized accounting knowledge, trustees usually required to be chartered or public accountants.
Customs and Excise Bond:	All businesses are required to collect federal and provincial tax on the goods or services sold by thm. Certain products are subject to payment of a duty which must be collected at the time of sale and submitted to Canadian government. Local, provincial and federal governments may require that bonds be filed with them guaranteeing the payment of taxes and duties.
Lost Document Bond:	Usually required when a valuable paper has been mislaid or destroyed. The organization that issued the document will agree to provide another one on the condition that this bond is filed with it. Bond guarantees that if the issuer suffers a loss by reason of having issued the replacement instrument, the principal and surety will undertake to indemnify the insurer. Can be issued on an open or fixed penalty basis.
Open Penalty Bond:	-Value of the lost document is subject to fluctuation. -Amount payable is unlimited. -Used for securities having frequent and varied fluctuation.
Fixed Penalty Bond:	-Value of lost document not likely to change significantly. - Used for losses involving certified cheques/investment certificates having a maximum predetermined value.

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CAIB 3 Chapter 5: Surety

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