Bond Violation

What is a Bond Violation

A bond violation is a breach of the covenants of a bond. A bond covenant is a legally binding term of the agreement between a bond issuer and a bondholder. Bond covenants are designed to protect the interests of both parties. The inclusion of the covenant is in the bond's indenture, which is the binding agreement, contract or document between two or more parties.

In a non-financial sense, a bond violation also means a person has broken the conditions of their bail bond.

Breaking Down Bond Violations

A bond violation occurs frequently in connection with the construction or building trades. There are several bonds which apply to these trades and which may have bond violations.

Surety. A surety is an organization or person that assumes the responsibility of paying the debt in case the debtor policy defaults or is unable to make payments. Surety is standard in contracts in which one party questions whether the counterparty in the agreement will be able to fulfill all requirements. A surety is not an insurance policy. The payment made to the surety company is paying for the bond. The principal is still liable for the debt.

Performance bond. Performance bonds are issued to one party of a contract as a guarantee against the failure of the other party to meet obligations specified in the contract.

Completion bond. A completion bond is a financial contract that ensures that a given project will complete, even if the contractor runs out of money, or if any measure of financial impediment occurs during the production of the project.

Maintenance bond. The maintenance bond is a type of surety bond purchased by a contractor that protects the owner of a completed construction project for a specified period against defects and faults in materials, work quality, and design that could arise later if the project was incorrect. 

Construction bond. A construction bond is a type of surety bond used by investors in construction projects to protect against disruptions or financial loss due to a contractor's failure to complete the project or to meet contract specifications. A construction bond is also called a construction surety bond or a contract bond.

Collateral and Bond Violations

A violation may also happen when the issuer of a secured debt sells or lessens the value of the collateral securing the loan. Collateral is a property or other asset that a borrower offers as a way for a lender to guarantee the loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup its losses. Since collateral offers some security to the lender should the borrower fail to pay back the loan, loans that are secured by collateral typically have lower interest rates than unsecured loans. A lender's claim to a borrower's collateral is called a lien.

Should a conflict arise between the issuer and bondholder, the indenture is the reference document utilized for conflict resolution. 

In the case of unsecured debt, if a person fails to make payments on unsecured debt, the creditor may contact them to try and receive payment. If the parties cannot reach a repayment agreement, the creditor's options include reporting the delinquent debt to a credit reporting agency, selling the debt to a collection agency and filing a lawsuit.

Example of a Bond Violation

Take for example a warehouse owner who hires a contractor to perform a seismic retrofit of the building. The owner may require the contractor to purchase a maintenance bond with a 10-year term. Assume two years after the work is completed the city experiences an earthquake, and the warehouse collapses, destroying its contents. Because the contractor's work failed to bring the building into compliance and resulted in damage, the contractor has committed a bond violation of the maintenance bond. 

Contractor Bonds and Bond Violations

In the United States, most states require contractors to obtain a contractor bond as a guarantee to potential clients that they will meet specific standards of operation relative to their industry. A construction or contractor bond is a type of surety bond and protects residential or commercial customers against outright fraud or against work that is below industry standards.

In legal terms, a contractor bond is a binding contract between three parties: a principal, an obligor, and a surety. The principal is the contractor who is seeking the bond for their business, the obligor is the organization imposing the bond requirement on the contractor, and the surety is an insurance company that guarantees the contractor's obligations. In the event of any claim, the surety company would pay the amount of the complaint, but would then be reimbursed by the principal.