Anatomy of a Bond

March 13, 2023

Surety bond forms can appear confusing at first glance. Here we’ll provide a general overview and a breakdown of the anatomy of a bond form.

STATUTE

Statute paragraphs generally start out with “Whereas” or “Now Therefore” and basically define why there is a bond obligation, the ordinances that support it, the statute(s) or the court case. It is generally a descriptive paragraph to limit your obligation to one specific statute or condition. If there is a reference to a particular statute or contract, it is essential to determine what the statute or contract guarantees.

1. WHEREAS, The Code of the City of Phoenix, Arizona states it shall be unlawful for any person to make, build, construct, remove, haul, cut, or grade pavement, driveway, sidewalk, curb, gutter, pipeline, or landscape in the public right-of-way of the City, without first having received a written permit from the Development Services Director, the plan for which has been approved by the Development Services Director
2. The Principal has applied to the Registrar of Contractors of the State of Arizona for a license to conduct the business of contracting under the above-described classifications and submits this bond to comply with the provisions of A.R.S. §32-1152, as amended, which are incorporated herein as though fully set forth.
3. The principal is a contractor who desires to engage in business in the State of Arizona and is required by law to execute a bond in compliance with all provisions of ARS § 42-5006. If the principal complies with all provisions of ARS Title 42, including, but not limited to, payment of all transaction privilege taxes, penalties, and other obligations incurred by the principal and which are adjudged due and owing by the principal during the term of this bond, this obligation is void; otherwise the obligation remains in full force and effect. After notice and a hearing pursuant to ARS Title 42, the Director of the Arizona Department of Revenue may order forfeited to this State and any affected political subdivision any part or all of the surety bond for nonpayment of those taxes, penalties or other obligations
4. THE CONDITION OF THE FOREGOING OBLIGATION IS SUCH, That whereas, the above bounden Principal has made application to the Division of Motor Vehicles of the Arizona Highway Department for the issuance of an Arizona Certificate of Title for the following described vehicle, to wit:
5. WHEREAS, the said Principal has not presented to the said Division of Motor Vehicles the regularly supporting evidence of ownership of the said vehicle; and WHEREAS, the said Division has requested said Principal to deposit with it a bond in accordance herewith as a condition to the issuance of an Arizona Certificate of Title for the said vehicle.
6. NOW THEREFORE, if the said Principal shall indemnify any prior owner and lienholder and any subsequent purchaser of the vehicle or person acquiring any security interest in it and their respective successors in interest against any expense, loss or damage, including reasonable attorney's fees, by reason of the issuance of the certificate of title of the vehicle or on account of any defect in or undisclosed security interest upon the right, title interest of the principal in and to the vehicle, then this obligation shall be null and void; otherwise to remain in full force and effect

CANCELLATION

Cancellations clauses are found in various bond forms, but not in all bond forms. The cancellation clause will show how and to whom cancellation notice must be given, either to the principal or the obligee (sometimes both), and how it must be delivered, either by regular mail, Registered Mail or Certified Mail.

Some states have regulations that limit or preclude the surety’s right of cancellation. It is important to know these terms up front as the cancellation notices must track with the law and/or underlying agreement.

If the law or agreement does not allow cancellation, the surety cannot cancel the bond even if a cancellation provision is contained in the bond form. With some laws or agreements, cancellation of the bond may cause forfeiture of the bond.

The following are some cancellation clauses found in various bond forms:

1. The term of this bond is continuous and regardless of the number of years it remains in force and effect, the liability of the surety shall not exceed the amount stated in this bond. This bond is effective the day of __, 20__, and shall continue in force until terminated as provided in this bond. The surety may terminate this bond after two years from this date by written notice to the Arizona Department of Revenue, 1600 W Monroe, Phoenix AZ 85007. Such termination shall become effective 30 days after the actual receipt of the notice by the Department. Termination of the bond does not affect any rights or liabilities which have accrued under this bond prior to the termination.
2. The Surety shall have the right to terminate this bond by giving the Principal and the State of Colorado, Colorado Office of Outfitters Registration thirty (30) days written notice of cancellation; however, such written notice of cancellation will not nullify or void any liability or indebtedness incurred or accrued by the Principal and Surety named herein prior to said date of termination.
3. This bond may be cancelled by the Surety in accordance with the provisions of Sections 996.310 et seq. of the Code of Civil Procedure.
4. THE CONDITIONS OF THIS BOND ARE SUCH, that when the above bounded Principal, his or her heirs, executors, administrators, successors or assignees have faithfully and truly complied with the provisions of work described below, to the satisfaction of the City of Phoenix, then this obligation will be released. Otherwise, it shall remain in full force and effect
5. IT IS FURTHER UNDERSTOOD AND AGREED between all parties hereto, That, if the Surety shall so elect, this bond may be cancelled by giving at least forty-five (45) days advance notice in writing to both the Principal and the Superintendent or other officer in charge of the Indian Agency or field office concerned, and this bond shall be deemed cancelled as of the date specified on such notice, the said Surety remaining liable for all acts covered by this bond which may have been committed by the Principal up to said date under the terms, conditions, and provisions of this bond

TERM

Some bonds have a specific term, rather than a cancellation clause. A term may be any period of time, but it is specifically spelled out in the bond. Because the bond does not have a cancellation provision, it will have to remain in force for the term stated in the bond form or statute.

Here are some examples of terms:

1. This bond shall be returned and surrendered at the end of three years from the date hereof or prior thereto in the event the said vehicle is no longer registered in the State of Arizona and the currently valid Certificate of Title is surrendered to the Division of Motor Vehicles. Provided, that such return or surrender of this bond shall not affect any liability theretofore incurred or accrued
2. THIS OBLIGATION may be continued from year to year by the issuance by the Surety of a proper continuation certificate delivered to the Director of Revenue; provided, however, that all such continuations shall be cumulative and shall have the legal effect of a new and separate obligation issued for the period covered by any such continuation certificate, and shall contain provisions therefor in the form approved by the Attorney General of Colorado.
3. NOW, THEREFORE, if the said Principal shall faithfully perform the duties and in all things comply with the laws and ordinances, including all Amendments thereto, pertaining to the license or permit applied for, then this obligation to be void, otherwise to remain in full force and effect for a period commencing on the day of _____ ,________ , 20 __ and ending on the day of ________ ,____________, 20 __ .
4. This obligation shall be a continuing obligation until and unless sixty (60) days' written notice of termination shall be given to the executive director of the Department of Revenue or his/her successor.

AGGREGATE LIABILITY

An aggregate liability clause limits the surety’s obligation to the bond penalty, regardless of the number of years the bond has been in effect or the number of claims filed. Most of the time the obligee is a branch of government to which any injured party may service notice of claim. It is important that the bond penalty not be construed to apply to each claimant. If this is the case, then the surety’s underwriting would change drastically. If a form does not contain a clause capping the aggregate, you cannot alter the form and add one. Most forms are statutory and follow the governmental bodies rules, regulations and statutes.

Some examples of aggregate liability clauses include:

1. Liability under this bond is limited to the penal sum for each classification of work performed by the principal. Liability under each classification shall be determined strictly in accordance with the provisions of A.R.S. §32-1152, as amended, which are incorporated herein as though fully set forth
2. PROVIDED, the aggregate liability of the Surety for all transactions occurring during any one license year shall not exceed the amount of the bond, regardless of the number of claims or claimants.
3. It is understood and agreed that: the aggregate liability of the Surety shall not exceed the penal sum of this bond; this bond is continuous in form; and, if the Surety so elects, this bond may be cancelled by the Surety upon thirty (30) day's written notice to Obligee, or thirty (30) day's after Surety's receipt of Obligee's written request therefore. No action may be commenced on this bond after two (2) years from the earlier of: the date on which the final inspection of the work in which the code violation occurred was performed by the jurisdiction having code enforcement authority; or the issuance date of a certificate of occupancy for the project in which the code violation occurred.

CUMULATIVE LIABILITY

The bond penalty may be applied each year the bond is in force if the bond contains a cumulative liability clause. Cumulative liability also exists in a term bond where the bond penalty applies per term for losses occurring during each term and where the surety has written the bond for more than one term. This, obviously, greatly increases the surety’s liability and is considered a hazardous clause.

Examples of cumulative liability clauses include:

1. THIS OBLIGATION may be continued from year to year by the issuance by the Surety of a proper continuation certificate delivered to the Director of Revenue; provided, however, that all such continuations shall be cumulative and shall have the legal effect of a new and separate obligation issued for the period covered by any such continuation certificate, and shall contain provisions therefor in the form approved by the Attorney General of Colorado.
2. FURTHER CONDITIONED that this new bond or continuation certificate shall be effective only with respect to manufactured home installations contracted for during the calendar year from (starting date) to (ending date), and PROVIDED, that the aggregate liability of Surety for manufactured home installations during the effective dates of this bond shall not exceed the face amount hereof, regardless of the amount of claims or the number of claimants, and FURTHER PROVIDED that this bond is revocable only upon written consent of the Director of the Division of Housing. This bond may be continued from year to year upon Surety's issuance of a continuation certificate delivered to the Division of Housing; provided, however that all such continuations shall be cumulative and shall have the legal effect of a new and separate obligation issued for the period covered by any such continuation certificate, and that each such continuation certificate must be on this form, as approved by the Division of Housing.

SUCCESSIVE RECOVERY

A successive recovery clause allows any number of claimants to recover up to the penalty of the bond. With this clause you have no limit of liability.

1. It his hereby declared, in accordance with the statute, that action on this bond may be brought and prosecuted in the name of any person damaged by any breach of the conditions thereof, and that successive actions may be maintained thereon.

THIRD PARTY LIABILITY

Third party liability gives individuals other than the obligee the right to direct action against the surety. This is now common with license and permit bonds. Third party liability is not a favorable clause from the surety’s standpoint because of the potential for nuisance claims, which increase the surety’s expenses.

1. This bond shall be subject to claims by any person who, after entering into a construction contract with the principal is damaged by the failure of the principal to perform the contract or by any person furnishing labor or materials used in the direct performance of a construction contract.
2. That any person aggrieved by an act of the principal named in this bond may proceed against the principal or surety or bot to recover damages.

FORFEITURE

This bond language is completely unfavorable to the surety company. In effect, all the obligee has to show is that part of the bond obligation has been breached and the entire penalty is paid. There is no prior proof of loss or damage needed. The forfeiture clause may not always appear in the bond form itself; however, it can be found in the statute or underlying agreement. This again brings out the importance of reviewing the statutes, ordinances or underlying agreement.

1. THE CONDITION of the foregoing is such that the principal and surety consent to forfeiture of the penal sum of said bond in the event of revocation of the liquor license held by the principal under the provisions of Chapter 131….

TIME LIMIT FOR CLAIMS

We as the surety prefer to see a clause that limits the time to file a claim and/or bring suit against the bond. The bond only covers losses that occurred during the term of the bond and/or licensure. You must refer to the underlying statute, as these clauses vary.

1. This bond shall be one continuing obligation, and the liability of the Surety for the aggregate of any and all claims which have been awarded by litigation and deemed uncollectible shall in no event exceed the amount of the penalty hereof. However, no suit may be commenced on the bond after the expiration of one year following the rendering of services on which the suit is based.
2. NO ACTION MAY Be COMMENCED on this bond after the expiration of TWO (2) YEARS following the commission of the act upon which the action is based.
3. THIS BOND and the obligation hereunder will remain in full force and effect until the contract identified herein ends or is terminated in accordance with its provisions. However, the surety may cancel this bond upon 120 days written notice given to the Postal Service and the Principal at any time after the expiration of the three-year period following the start of the bonded contract. In addition, the surety may cancel this bond at any time that the surety has the written consent of both the Postal Service and the Principal, or that the Principal furnishes to the Postal Service a substitute bond on terms equivalent to this bond with a surety satisfactory to the Postal Service.

For more information on RLI Surety Bonds, go to rlicorp.com/rli-surety-bonds.