"Collateral" refers to assets or things a value that a surety company may accept as security for and in support of a surety bond. Acceptable collateral for surety companies are generally liquid (cash) or instruments that are easily redeemed for cash. The collateral protects the surety from loss if there is a breach, claim and/or loss under a bond or bonds. Sureties generally do NOT accept real property, tangible assets, UCC filings or any type of assignment or lien on assets. Appeal and supersedeas bonds, mechanic's lien release bonds and high risk financial guarantees are good examples of bond classes that require the support of collateral security however any principal whose financial condition and/or creditworthiness does not meet underwriting thresholds will often be offered terms that include collateral. The amount required depends on the nature of the obligation, the principal's financial position and the bond class loss history. These are acceptable types of collateral.
- Irrevocable Letter of Credit.
- U.S. Treasury-issued securities.
As they say, "cash is king". Cash collateral is preferred because in the case of a claim or surety bond forfeiture, the surety avoids the administrative burden of corresponding with the collateral issuer to redeem the instrument and the costs associated with delivery and wire of liquidated instruments. Cash collateral must be wired to the company and remains in the custody of the surety until evidence solely acceptable to the surety is received that substantiates full and irrevocable release of the surety's obligation.
Irrevocable Letter of Credit
An irrevocable letter of credit (iLOC) is an instrument issued by a bank that guarantees payment of a debt or liability of an individual or business entity if the beneficiary demands the same. An iLOC cannot be canceled or modified except with the absolute agreement of the issuing bank and surety company. The surety bond underwriter will review the rating of a financial institution proposed by a bond principal to determine if it is acceptable the provide the iLOC format. A sample irrevocable letter of credit may be viewed here. The original iLOC must be delivered to the company before a surety bond is executed and released for delivery. Letters of credit must follow the most recent circular issued by the ICC (International Chamber of Commerce). The most current acceptable rule publication is #600.
U.S Treasury Securities
The option of the deposit of securities is limited to principals that require surety bonds with penalties in excess of US$5,000,000. The securities must be CUSIP'd to the custody of Surety One, Inc. or its surety partner or in a custodial accept established jointly between the bond principal and surety or the surety's managing general agency.
Release of Collateral Security
Pursuant to the surety bond and collateral agreement between the bond principal, surety and surety's managing general agency, collateral is released back to a principal only after evidence is received that the surety has been fully and irrevocably released from its obligation. The surety decides UNILATERALLY what constitutes "acceptable evidence" of the exoneration of a bond. Each bond class is released in a particular manner. Some examples:
- Judicial bonds are released by orders issued explicitly by the court holding jurisdiction over the controversy for which the bond was required.
- Mechanic's lien release bonds are exonerated by the lien claimant's absolute release of the surety accompanied by a notice of satisfaction of the lien debt. If a lien claimant has initiated litigation in prosecution of the lien, the a court order releasing the surety is required. *NOTE: The expiration of the statutory window within which a lien claimant's must initiate collection/prosecution of the lien is NOT in and of itself acceptable evidence that the surety is released. Filing by a lien claimant of a "release of mechanic's lien claims" is likewise unacceptable, as the lien in controversy was "bonded off" of the parcel of real property by our bond, i.e., there is no "lien" to release. Return of the original bond must be pursued under this latter scenario.
- Contract surety bonds are exonerated by the release letter issued by an obligee (project owner) of the surety (all obligations; performance, labor/material payment, maintenance, etc.)
- Commercial surety bonds are released by the issue of a cancellation notice by the surety, the expiration of the bond's tail (claim period) and return of the original bond.