Surety bonds provide valuable protection to
consumers and are often legally mandated for select businesses. Surety bonds
act as a legal contract that ensures an agreement is executed properly and
Surety companies sell surety bonds and
essentially make a promise that the agreement will be carried out properly or
proper compensation (up to a predetermined amount) will be arranged to make up
for a failed agreement or predatory behavior on the bond holder’s side.
Keep reading for more insight into what surety
bonds are and how they work.
Surety bonds guarantee that certain parties
operate within the law and fulfill their contract term or financial recompense
for the wronged party can be pursued. For example, performance and contract
bonds guarantee that a project is completed and meets certain expectations or
proper compensation is provided.
Surety bonds don’t just benefit the party that
can file a claim against the bond if something goes wrong. When a business
purchases a surety bond they benefit as well. To start, by doing so they are
complying with state and federal requirements. Not only does this make it
possible to operate their business legally, but their clients can have
confidence knowing the business is running a legal operation with good
practices. It can be much harder to secure projects without having a legally
required bond as most contracts will require that.
A surety bond also helps businesses
financially as once they have a surety bond they won’t need the entire amount
of cash required to pay out a claim on hand. When taking out a surety bond, you
only pay a premium which is a much smaller percentage of the bond amount. If a
claim is filed and approved by the surety company, they will pay out the claim
initially and then the business will need to pay them back.
Surety bonds always involve three different
Principal. The party that must take out the
Obligee. The party that requires the bond—this
can be the client or a government.
Surety. The company that issues the surety
bond and ensures that the principal fulfills the contract. They will pay out
any approved claims initially.
There are hundreds of different types of surety
bonds on the market and which one a business needs can greatly vary by state
and industry. We can’t walk through all of them because the list is so varied,
but these are a few examples of popular bond types.
Contractor license bonds. This type of bond is
usually required by a governing agency (usually a state/local municipality) in
order to become a licensed contractor.
License and permit bonds. Municipalities often
require license permits and bonds to protect consumers against dishonest
practices by ensuring that licensed professionals comply with certain laws and
Performance and payment bonds. An obligee may
require a performance and payment bond to ensure the contractors complete their
project properly and pays all subcontractors and vendors involved.
Motor vehicle dealer bonds. Automotive
dealerships generally need to obtain a motor vehicle bond that protects
consumers when the dealer misrepresents a vehicle, fails to pay necessary fees
and taxes on the vehicle, does not obtain a valid title, or does other
Site Improvement bonds. This type of bond is
used by developers and builders to ensure that site improvement projects to
roads, sewers, electric facilities, and other structures are properly
Surety bonds are purchased by the principal,
but for the most part they are designed to protect consumers against issues
llike incomplete work, and shoddy workmanship. Having a surety bond can give
consumers and other businesses the confidence to work with the bonded business
because they know the business in question has a financial safety net to cover
the cost of claims when they don’t meet your end of the deal—such as losses,
damages, and legal fees.
To better understand how a surety bond works,
it helps to know what the following terms mean.
Bonding capacity. This is the maximum amount a
principal can claim when a project doesn’t go according to plan. If the maximum
bonding capacity is $10,000 then the obligee can’t claim more than $10,000 for
Bond premium. The bond premium represents how
much the principal will spend on the bond and is typically 1% to 15% of the
Bond term. Bond terms represent how long the
surety bond is active and typically ranges from one to three years and are
Remember—surety bonds don’t let the principal
off the hook for a claim like some insurance policies do. While the surety
company will initially pay the claim out, the principal will eventually be
responsible for repaying any amount (up to the bonded amount) that the surety
used to settle the obligee’s claim against the bond.
Need a surety bond? Learn more about how Worldwide Insurance Specialists, Inc. can help you cover your needs today!