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.
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Surety Bond Definition and
Examples
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How Does a Surety Bond Work?
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Types of Surety Bonds
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Surety Bond vs. Insurance
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Advantages of Surety Bonds
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How to Get a Surety Bond
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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.
Difference Between Surety
Bonds and Insurance Policies |
|
Surety Bond |
Insurance |
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:
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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.