A surety bond is a contractual agreement ensuring that a project will be completed. Learn how the surety bonds work and how you can get one in 2022.
A surety bond is a legal contract between
three parties that guarantees specific obligations are met or compensation is
provided. In other words, a surety bond helps to ensure the job gets done.
The type of surety bond required will depend on your state and industry. If you’re a contractor or a licensed professional, chances are — you need one. The good news is that surety bonds help you land valuable contracts (and keep you out of legal or financial hot water).
Keep reading to learn how surety bonds work, the different types, and how to get them.
● Surety Bond Definition and Examples
● How Does a Surety Bond Work?
● Types of Surety Bonds
● Surety Bond vs. Insurance
● Advantages of Surety Bonds
● How to Get a Surety Bond
● Surety Bond FAQs
A surety bond is a legal contract that ensures an agreement is carried out properly. When a surety company sells a surety bond, they are promising to one party that the other party (usually a small contractor) will fulfill their contract terms. If the contract is not executed fully or properly, then the surety bond company steps in to resolve the situation — typically with a refund up to a predetermined amount.
As mentioned, a surety bond involves three parties:
● Principal: The party that needs the bond (you)
● Obligee: The party that requires the bond (typically the client or government).
● Surety: The company that issues the surety bond and ensures that the principal fulfills the contract.
A business owner (obligee) is expanding and hires a construction contractor (principal) to build a new office. Before beginning work, the business owner requires the contractor to obtain a surety bond for $100,000. The contractor obtains a surety bond from Construction Bonds, Inc. (surety).
Now, let’s say the construction contractor messed up and can no longer complete the project. The business owner files a claim against the bond and Construction Bonds, Inc. issues financial recompense of $100,000 to cover the project losses.
There are three terms to keep in mind when researching surety bonds: capacity, premium, and term.
● Bonding capacity: The maximum amount a principal can claim when a project goes south. If the maximum bonding capacity is $10,000, for example, the obligee can’t claim more than $10,000 for reparations.
● Bond premium: What the surety company charges the principal — typically 1% to 15% of the bonded amount, depending on the type. For example, a 3% premium on a $10,000 bond would be $300.
● Bond term: How long the surety bond is active. Terms typically range from one to three years and are renewable.
Surety bonds are purchased by the principal but their function is to protect the obligee against incomplete work, shoddy workmanship, and more. When you are bonded, it tells your client that you have a financial safety net to cover the cost of claims when you don’t meet your end of the deal. That includes losses, damages, and legal fees.
While a surety bond is handy when a dispute arises, don’t think you’re off the hook financially. Yes, the surety company compensates the client if you fail to complete a contract. However, the principal — that’s you — is still responsible for repaying any amount (up to the bonded amount) that the surety used to settle the obligee’s claim against the bond.
The number of surety bonds available is far more than you can count on two hands, or ten. With hundreds of bonds out there, the required ones will vary by your industry and state. Some common surety bonds include:
● Contractor License bonds: A Contractor License Bond is a Surety bond that a governing agency (usually a state/local municipality) requires for becoming a licensed contractor
● License and permit bonds: Often required by municipalities to protect the general public against dishonest practices, this bond ensures that licensed professionals comply with certain laws and industry regulations.
● Performance and payment bonds: Obligees often require this to ensure that contractors complete the project properly. The bond terms also guarantee that all subcontractors and vendors involved in the project are paid for their services.
● Motor Vehicle Dealer Bonds: A required bond for an automotive dealership. This bond protects consumers when the dealer misrepresents a vehicle, fails to pay necessary fees and taxes on the vehicle, does not obtain a valid title, and does other questionable practices.
● Site Improvement bonds: Typically used by developers and builders, this bond ensures that site improvement projects to roads, sewers, electric facilities, and other structures are properly completed.
Contract between three parties (principal, obligee, surety)
Contract between two parties (insured and insurance company)
Protects the obligee (e.g., business owner, government agency)
Protects the insured party
Protects against incomplete contractual obligations (e.g., building construction not finished)
Protects against covered incidents (e.g., negligence, theft, physical disasters)
Surety settles the bond claim, but the principal is still financially liable
Insurance reimburses the insured for financial loss
The most obvious benefit of a surety bond: you’re complying with state and federal requirements. Your clients can rest easy knowing that you’re running a legal operation with good practices. In many contract terms — especially when working with the government — a project can’t move forward until you are properly bonded. That means revenue loss for your business if you don’t meet the bonding requirements.
Secondly, a surety bond helps you to guarantee the bonded amount without necessarily needing the entire amount on standby. Can you imagine the client requiring that you have $100,000 in cash, just in case things go wrong? With a surety bond, you only need to pay a small percentage of the bonded amount — a $2,000 premium for a $100,000 bond, for instance.
Surety bonds are commonplace for many businesses — those that work in the construction industry or with municipalities, for example. License and permit bonds may also be necessary for certain professionals, such as electricians and auto dealers. However, surety bonds are not necessary for some types of businesses. Be sure to research your federal and state requirements to determine the necessary surety bonds for your business, if any.
Generally, sureties will want to take a look at your credit score, how long you’ve been in business, and your business financials. Depending on the surety company and the bonded amount — $1 million, for example — the requirements can be extensive:
● Minimum credit score 650
● Three years time in business
The surety may also want to review your personal and business financial statements, including tax returns, cash flow history, and profit and loss statements.
QUICK TIP: A high credit score, strong business financials, and experience will typically qualify you for a lower bond premium.
An indemnity agreement may also apply for certain surety bonds. An indemnity agreement is a legally binding contract that holds you responsible for paying for losses and damages up to the full bond amount when the obligee files a claim. Some sureties will require you to pledge collateral to guarantee the bond, similar to applying for a loan.
Surety bonds are commonly available through insurance companies. Insurance companies often have subsidiaries or a dedicated division that handles and issues surety bonds. In some cases, they may contract with a surety bond producer that functions similarly to a broker and sells surety bonds on their behalf.
Obtaining a surety bond is easy when applying with Worldwide Insurance, Inc. Just fill out our initial application form and get an instant quote in minutes. We issue all types of surety bonds in all 50 states. No credit check required and no obligation.
Surety bonds ensure certain parties fulfill their contract terms and operate within the law. Performance and contract bonds, for example, guarantee that a project is completed and meets certain expectations or proper compensation is provided. A guardianship or conservator bond helps to guarantee that the guardian or conservator acts in the best interest of the minor or conservatee.
Surety companies typically charge a one-time upfront fee when obtaining the surety bond. You would need to pay another fee to renew the surety bond term.
The terms on surety bonds will vary by type and state. Most motor vehicle dealer bonds, for example, have terms of one year but can extend up to three years in Oregon. For many surety bonds, you will have the option to renew the term.
The cancellation process can vary by the bond type, state, and surety company. A written agreement signed by all parties may be necessary for canceling the bond. In some cases, a full or partial refund is possible but not guaranteed.