What Does “Penal Sum of Bond” Mean?
Every surety bond has a penal sum, so it’s important to understand this key concept. Simply put, the ‘penal sum of bond’ is the maximum compensation a surety bonds company can extend to a claimant who has made a valid claim against a surety bond.
Let’s take an auto dealer bond as an example. If a car-buyer files a successful claim against a dealer, and the penal sum of the dealer bond is $50,000, this means the surety can compensate the claimant for sums up to $50,000.
It’s important to understand, however, that even though the surety may initially extend this compensation, this does not free you from the responsibility. Indemnity agreements are standard in the industry, meaning that the owner of the bond will have to eventually reimburse the surety.
How is the penal sum of bond determined?
There are thousands upon thousands of surety bonds in the U.S., and every state has some sort of bonding requirement for different industries. It is up to each state or government agency to decide an appropriate amount.
Usually, this is done after an assessment of the volume of claims, or violations, a particular industry is experiencing. The penal sum must be a sufficient amount, so that all potential claimants can receive adequate compensation. Sometimes penal sums are adjusted upwards or downwards if there has been a significant period of increased or decreased volume of claims, respectively.
For contract bonds, the penal sum is most often 10%-20% of the total contract amount.
Disambiguation: A bond’s penal sum vs. its cost
You shouldn’t confuse a bond’s penal sum with its cost. Surety bonds are paid in premiums, which are just a percentage of the penal sum. For license bonds, which need to be valid for the whole licensing period, premiums are paid annually or biannually. For contract bonds, required on large construction projects, premiums are one-time payments.
As mentioned in the beginning, you may only need to pay the bond’s penal sum if you have breached the bond agreement and there has been a valid claim against you.
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