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A surety bond is a three-party agreement that provides a financial guarantee that the bonded party will fulfill their obligations as determined by the agreement. The three parties involved are:
The Obligee: The party requesting the bond (e.g. a government entity)
The Principal: The party required to get bonded (e.g. contractors, auto dealers, freight brokers, mortgage brokers, etc.)
The Surety: The company that issues the bond and backs it financially
What Are Surety Bonds Used For?
Surety bonds are required by some government entities and private parties because the bonds serve as financial guarantees that the principal will perform its contractual obligations and business deals according to the agreed-upon terms and will comply with all applicable laws. Surety bonds protect the public and the government from malpractice, fraud, theft, and other unethical practices. If a principal violates the law or the bond terms, the party that suffered harm can file a claim against the bond to recover compensation for the financial loss.
Surety bonds are not insurance and do not protect the principal from liability. Instead, these bonds protect consumers and the government. If a claim is filed against your bond, the surety company will investigate it. If it determines that the claim is valid, you will be responsible for paying it. If you don't, the surety company will step in and pay it, but it will then pursue a legal claim against you to recover what it paid on the bond claim.
Surety bonds help to keep bad actors from taking advantage of the public or the government. They help to screen out individuals with poor character and prevent potential fraud and abuse.
What Are the Types of Surety Bonds?
There are three primary types of surety bonds. Each type is discussed below.
Contract Surety Bonds
Contract surety bonds are common in the construction industry and serve to induce the obligee, including a government agency or a project owner, to agree to enter into a construction contract with the principal to perform work or submit a bid. There are a variety of different types of contract bonds, including the following:
- Bid bonds - Provide guarantees that contractors that submit bids on construction projects will enter into contracts if the project owners accept their bids
- Payment bonds - Provide guarantees that the contractors will pay their subcontractors for the work that they perform on construction projects
- Performance bonds - Provide guarantees that the contractors will perform their contractual obligations as agreed to in their contracts
- Maintenance bonds - Provide guarantees that the contractors will meet their obligations to clean up the job site and make repairs after the project is completed
Commercial Surety Bonds
A commercial bond includes a variety of different types of bonds other than contract bonds or court bonds. Two common types of commercial surety bonds include license bonds and permit bonds. For example, you might be required to get a bond before a professional license will be issued to you. License and permit bonds are meant to ensure that you will comply with the law.
Certain types of public officials are required to get commercial surety bonds, including notaries, judges, government officeholders, and others. Another type of commercial surety bond is a fidelity surety bond. This type of bond protects a business's clients or customers from the business's employees' actions. For example, a brokerage firm might purchase a fidelity surety bond to protect itself against embezzlement by its employees.
Court Surety Bonds
Court bonds are used for various reasons in court proceedings. For example, bail bonds in criminal cases guarantee the defendants will appear in court for future hearings and trials. There are a variety of different types of bonds that are required in civil cases as well. Some examples of civil case judicial bonds include the following:
- Appeal bonds to protect prevailing parties from damages caused by the delay of an appeal filed by the losing parties
- Mechanic's lien bonds to protect defendants from damages caused by mechanic's liens
- Injunction bonds to protect defendants from damages caused by injunctions
- Attachment bonds to protect defendants from damages caused by attachments
There are also bonds that are specific to probate court proceedings. People who are appointed by the probate court to serve as executors, guardians, administrators, or trustees have fiduciary duties to perform the tasks of their roles in good faith and with loyalty and honesty. Probate surety bonds are known as fiduciary bonds, and they provide a guarantee that the administrator, executor, trustee, or guardian will perform their duties for the benefit of the beneficiaries.
There are many other situations where someone might be required to purchase a surety bond.
Who Needs a Surety Bond?
Bonds are most frequently required for obtaining a business license or permit. Some of the businesses commonly required to obtain license and permit bonds are auto dealers, mortgage brokers, contractors, freight brokers, telemarketing agencies, and many more. Typically, your state or local government determines these bonding requirements. You can contact your state’s licensing authority to find out if you need a surety bond for your business.
Surety bonds are also required of contractors who want to bid or perform work on a construction project. They are also frequently required as a payment guarantee for subcontractors. Whether you need to get bonded under a construction contract is determined on a case-by-case basis by project owners. Most state and federal construction projects will require contractors to get bonded. These bonds are called construction bonds.
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How to Get a Surety Bond?
People are not automatically approved for surety bonds. Instead, when you submit an application to a surety company, your application and supporting documents will be submitted to a surety underwriter and go through the underwriting process. During underwriting, the underwriter will evaluate multiple factors to determine your level of risk to the surety company. The underwriter will evaluate some of the following factors when assessing the risk that you pose:
- Personal credit history and credit score
- Business credit history
- Available working capital
- Experience handling similar projects in the past
- Moral character
- Business's relationships with past clients, suppliers, and distributors
- Whether any claims were filed against a past surety bond
- Loss history of your bond type in your location
Once your level of risk has been assessed by the underwriter, you will be assigned to a category of risk according to the underwriting factors and the type of bond you are seeking. Each bond category will have an assigned bond rate. The rate is a percentage of the total bond amount that you need.
If the surety agrees to approve your bond application, it will give you a free quote of the bond rate. The bond rate will be a percentage you will have to pay upfront as a bond premium.
If you have great credit, substantial business experience, and a spotless record when working with past clients, distributors, and suppliers, you will be quoted the best rates and might have to pay as little as 1% of the total bond amount.
By contrast, if you have poor credit, limited experience, or past bond claims, your application might be denied. If the surety company does agree to issue you a surety bond, you will likely be quoted much higher rates and might have to pay up to 10% or more of the total bond amount to secure your bond.
Read more about how to get bonded.
How Much Does a Surety Bond Cost
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The surety bond cost will vary according to the applicant's risk. For example, if you need a $50,000 surety bond, and the surety company determines you to be of low risk, you might be quoted a rate of 1%. This would mean that the upfront surety bond premium you would have to pay the surety company for your bond would be $500.
By contrast, if you have poor credit and are quoted a rate of 10%, you would have to pay a bond price of $5,000 upfront to secure your bond because of the fact that you have been assessed to pose a higher risk of violating your bond requirements and having claims filed against your bond.
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