STEPHEN BAULD - This is another procurement issue that has come up time and time again over the past year. Surety bonds are the most ancient and quite probably the most common form of security mechanism employed by Canadian municipalities.
Sureties date back at least to Biblical times.
In Canada, surety bonds are a species of guarantee agreement, usually issued by a bonding or insurance company.
Surety bonds differ from letters of credit in that they are obligations that become payable “on default” whereas a letter of credit is an obligation payable “on demand” or “on presentation of a draft.”
The liability of a surety under such a bond is collateral to that of the principal obligor, in this case GCC. As a general rule, a surety is liable only in the event of default by the principal.
The surety’s liability extends, at the maximum, only to the extent of the actual damage sustained.
However, there is no presumption that the liability of the principal and the surety are co-extensive.
Very often the damages for which the surety is liable will be less then those for which the principal is liable.
Surety bonds take the form of a written promise under seal which commits its issuer (the “surety”) to pay a named beneficiary, called the “oblige,” a sum up to a stipulated amount, but subject to the proviso that the obligation of the issuer will cease if certain specified conditions are met.
A bond may be either absolute, in which case it is known as a simple bond, or conditional.
Most commercial surety bonds are conditional and include extensive exculpatory clauses.
These conditions will invariably relate to the manner in which claims are to be made, the timelines of such claims and the performance of the principal.
By virtue of the relevance of the principal’s performance such bonds, like simple guarantees, are an “on default” obligation, in contrast to bank performance guarantees which are independent obligations to pay.
In any given case, further conditions upon payment beyond the existence of a default by the surety may also be imposed. The scope of the liability of the surety is a matter of contractual interpretation.
Most surety bonds have three parts: (1) the obligation, or operative part of the bond, which defines the obligation of the surety; (2) the recitals which explain the transaction and its factual content; and (3) the conditions of the bond.
In general, the surety is entitled to the full range of rights and defences to which guarantors generally are entitled under law of guarantee.
As in the case of all guarantees, the liability of the surety is collateral and dependent upon the liability of the principal.
Thus the surety is liable to the obligee only for the actual damages sustained by the obligee as a result of the non-performance of the principal.
In most cases, the bond will provide the surety with a right to elect between paying the amount of damages suffered by the obligee (up to the limit of the bond) and performing the guaranteed obligation itself.
Accordingly, the surety will usually insist upon receiving notice of any default by the principal.
The surety must elect within a reasonable time which option it intends to pursue, to complete, corrector or to pay.
If it elects not to complete the work, it cannot complain when another company is hired to do that work.
Commercial surety bonding is an outgrowth of fidelity bonding.
Fidelity bonds originally provided a guarantee only of the honesty of the principal.
In most cases, they were obtained by employers as a means of protecting themselves against loss as a result of an employee breaching a duty of confidence or stealing the property of the employer.
Stephen Bauld is Canada’s leading expert on government procurement. He can be reached at email@example.com. Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.