Surety and Fidelity Bonds
Key Takeaways
- Surety is a three-party credit guarantee: principal (pays/owes), obligee (protected), surety (guarantees); a paid claim is recovered from the principal under the General Indemnity Agreement.
- Federal construction over $150,000 (FAR 28.102, implementing the Miller Act) requires both a performance bond and a payment bond, each generally at 100% of the contract price.
- Contract bonds: bid (will sign), performance (will complete), payment (will pay subs/suppliers), maintenance (defect-free for a period).
- Fidelity bonds protect an employer against its own employees' dishonesty and behave like insurance - no reimbursement from a faithful third party.
- License/permit, public official, and court (fiduciary, appeal, attachment) bonds are the main non-construction surety categories.
Bonds Are Credit, Not Insurance
A surety bond is a three-party guarantee that one party will perform an obligation owed to another. Unlike an insurance policy, where the insurer assumes an expected loss in exchange for premium, the surety lends its credit and financial strength, fully expecting the principal to perform. The bond premium is effectively a fee for that credit, not a pooled loss charge.
Quick Answer: A surety bond guarantees performance or payment. If the surety pays a claim, it recovers from the principal under a general indemnity agreement, so the loss is the principal's debt, not the surety's.
This distinction drives most exam questions. A standard insurer generally cannot subrogate against its own insured; a surety, by contrast, holds a right of reimbursement against the principal and any indemnitors who signed the General Indemnity Agreement (GIA).
The Three Parties
| Party | Role | Construction Example |
|---|---|---|
| Principal | Owes the obligation; buys the bond | The contractor |
| Obligee | Protected party; requires the bond | The project owner / government agency |
| Surety | Guarantees the principal's obligation | The bonding company (insurer) |
Memorize the direction of protection: the obligee is protected, the principal pays, and the surety stands behind the principal. The principal is never the protected party even though the principal pays the premium.
Contract (Construction) Surety Bonds
These guarantee a construction project. Tested heavily on the national portion:
| Bond | Guarantees |
|---|---|
| Bid bond | The contractor will enter the contract and furnish required bonds if awarded the job |
| Performance bond | The project will be completed per the contract terms |
| Payment bond | Subcontractors, laborers, and suppliers will be paid |
| Maintenance bond | Workmanship is free of defects for a stated period after completion |
Miller Act (federal projects): The statute references $100,000, but the operative figure under the Federal Acquisition Regulation (FAR 28.102) is $150,000 - federal construction contracts above that amount require both a performance bond and a payment bond, each generally for 100% of the contract price. The Little Miller Acts are the state-level equivalents for public projects.
Commercial Surety, License & Permit, and Court Bonds
Beyond construction, surety divides into recurring categories:
- License and permit bonds - required of contractors, auto dealers, mortgage brokers, etc., to obtain a license; they guarantee compliance with the licensing law and protect the public.
- Public official bonds - guarantee an officeholder (treasurer, notary) faithfully performs duties.
- Court / judicial bonds - include fiduciary bonds (guardians, executors, administrators) and litigation bonds (appeal bonds, injunction bonds, attachment/replevin bonds).
A Worked Penalty Example
A contractor wins a $2,000,000 federal job. Under the Miller Act/FAR, both the performance and payment bonds are written at 100% of the price - $2,000,000 each. If the contractor defaults and the surety spends $2,300,000 to complete, the surety's liability to the obligee is capped at the $2,000,000 penal sum of the performance bond; the surety then pursues the full $2,300,000 from the principal under the GIA.
Fidelity Bonds vs. Surety Bonds
A fidelity bond is technically a bond but functions like insurance: it protects an employer (the insured/obligee) against loss from dishonest acts of its own employees - theft, embezzlement, forgery. There is no expectation of reimbursement from a faithful third party; the employer simply transfers employee-dishonesty risk.
| Feature | Surety Bond | Fidelity Bond |
|---|---|---|
| Parties | Three (principal, obligee, surety) | Two functionally (employer + insurer) |
| Protects against | Principal's failure to perform | Employee dishonesty |
| Reimbursement | Surety recovers from principal | None - acts like insurance |
The ISO/SFAA Commercial Crime program overlaps here: the Employee Theft insuring agreement is the modern successor to the old blanket fidelity bond. Watch the trap - a fidelity bond covers employee dishonesty, not loss caused by an outside burglar (that is robbery/burglary coverage).
Underwriting, Penal Sums, and Common Traps
Surety underwriting is built on the three Cs: Capital (the principal's financial strength), Capacity (the technical ability to do the work), and Character (track record and integrity). Because the surety expects no loss, underwriting resembles bank credit analysis far more than property-casualty loss rating - the surety reviews the principal's working capital, bonding line, completed-projects history, and the personal guarantees of owners.
The penal sum is the maximum the surety will pay the obligee on any bond. It caps the surety's exposure even if completion costs exceed it; the surety then pursues the overage from the principal. A bond does not add limits the way an umbrella does - it is a fixed dollar guarantee.
Exam traps to memorize:
- The principal pays the premium but is never the protected party - the obligee is.
- A surety can recover from its principal; an insurer generally cannot subrogate against its own insured. This is the single most-tested distinction.
- A bid bond does not guarantee completion - only that the bidder will enter the contract and post the required performance/payment bonds.
- A fidelity bond is not surety in function: it covers employee dishonesty and behaves like insurance, with no faithful third party to reimburse the carrier.
- On federal jobs, the controlling threshold is $150,000 (FAR), not the $100,000 the Miller Act statute recites.
After a bonded contractor defaults, the surety spends $250,000 completing the project. What may the surety do about that payment?
An employer suffers a $40,000 loss when its bookkeeper embezzles funds. Which coverage responds?