Surety bonds are a promise by a surety company to pay a first party if a second party fails to meet its obligations. They protect the third party that is hiring a business from any potential losses that could arise from incomplete work, damage and other failures of the hired business. If such losses do occur, the third party can file a claim and receive compensation for the loss from the surety company, which would then be repaid by the purchaser of the bond.
Who is involved in a surety bond?
A surety bond represents an agreement between three parties.
The Principal is the purchaser of the bond and is the business that is providing its service to others.
The Obligee is the entity that requires the bond before allowing the principal to do business. Often, the obligee is a state, municipal or other government institution but commercial and professional parties can also use bonds.
The Surety is the insurance company that issues the bond.
What does it mean to be bonded?
A bonded business is one that has purchased a surety bond. Surety bonds provide a guarantee that your business will fulfill the terms of a contract. Unlike other types of insurance, the bond carrier (the surety) will expect reimbursement when it pays a claim. Surety bonds assist principals, usually small contractors, compete for contracts by assuring obliges that they will receive the service or product as outlined in the contract.
How does a bond work?
The principal will pay a premium to the surety in order to obtain the surety bond. The bond itself requires the principal to sign an agreement that pledges the business assets to reimburse the surety if a claim occurs. If the business assets aren’t sufficient or are uncollectable, the surety will pay its own money towards the claim.
Parts of a surety bond
Bonding capacity is the maximum bond amount a principal can obtain. This figured is calculated by the surety using the principal’s working capital, cash flow, experience and other financial records.
Bond term is the length of the bond and is outline in the contract between the principal and the obligee.
Bond terms are typically between one to four years but can usually be renewed if needed.
Working capital is a principal’s current assets less their current liabilities. Sureties require principals to have a certain amount of working capital in order to offer them a bond.
Bond premium is often a percentage of the bonded amount. It is charged by the surety and paid by the principal.
What types of bonds are there?
There are many different types of bonds. Some of the most common types of bonds are explained below.
Contract surety bonds are often used to guarantee the performance of a contractor as it relates to a construction contract.
- Performance bonds protect the obligee if the contract fails to complete a project as required.
- Payment bonds guarantee that the contractor will pay its subcontractors, laborers and suppliers as specified in the contract.
- Bid bonds ensure that a contractor can meet the requirements of the bids they submit and that they won’t back out of a project if the bid is won.
- Maintenance bonds are sometimes called warranty bonds and they protect a project owner from losses resulting from defective workmanship or faulty materials.
Janitorial surety bonds can reimburse clients for incomplete work or employee theft. They are often required to be carried by professional cleaning companies.
Fidelity surety bonds help business protect themselves from employee theft, fraud and dishonesty. They can also protect against unlawful digital access.
- Employee dishonesty bonds protect against losses resulting from an employee’s dishonest acts. This type of bond is often used by non-profit organizations.
- Business services bonds defend against employee theft of or damage to client and customer assets, like money or belongings.
- ERISA bonds protect pension and retirement plan participants from malpractice by the employees that manage the plans.
Commercial surety bonds are used by government entities to protect public interests. These types of bonds are used by licensed business as a way to ensure that they follow regulations and codes that relate to the well-being of the general public. Liquor stores, notaries, auto dealers and licensed contractors are common principals for this kind of bond.
- License and permit bonds are required by government agencies when professionals, like a plumber or electrician, apply for a license.
- Mortgage broker bonds ensure that mortgage brokers adhere to state regulations and protects borrowers from those that don’t.
- Other bonds apply specifically to certain industries, like lottery-ticket sellers, fuel sellers and travel agents.
Court surety bonds protect individuals or business from losses during court cases. They can be used by plaintiffs and defendants and even estate administrators.
- Cost bonds ensure payment of court costs during litigation
- Administrator bonds guarantees that an estate administrator performs their court-appointed duties.
- Guardianship bonds ensure that guardians will act in the best interest of the incapacitated or underage person.
- Attachment bonds are required to be obtained by courts before they seize someone’s property. They guarantee that defendants will be reimbursed for any damages resulting from the seizure.
The city of Anytown hires a contractor to re-pave Main Street. Partway through the job, the paving contractor’s project manager quits and leaves the project unfinished. Anytown could file a claim with the surety for the cost of hiring another contractor to complete the project. The original paving contractor would then be obligated to reimburse the surety.