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Surety Bond Definition
A surety bond is a three-party legally binding agreement between an obligee, a principal and a surety bonds company. This agreement guarantees to the obligee that the principal will act in accorance with the terms of the bond language. Usually, the purpose of surety bond is to protect third parties who suffer loss as a result of the actions of the principal. They can file the claim and obtain quick compensation thanks to the surety's backing of the bond.
Below you can find more information about the three parties involved:
The obligee on a bond is the party requiring that the principal obtains the bond, in most cases, prior to getting a license or a permit. Typically, the obligee is a government agency using surety bonds to regulate a certain industry.
The principal is the party required to obtain the bond. Principals are most frequently businesses applying to get licensed or construction contractors who have won a contract and must post a surety bond prior to commencing work on the project.
The surety (also known as the bonding company) is the party that takes the risk by backing the surety bond financially up to the full amount of the bond. It provides the financial guarantee in case the principal fails to fullfil their obligations according to the bond agreement. In order to have this guarantee, the principal has to pay a premium to the bonding company.
Still unsure about the bonding agreement and the role of the three parties? Watch our quick video guide for some real-world examples, then scroll the sections below.
How Does a Surety Bond Work?
People often mix up surety bonds and insurance, but there is a major difference between the two and how they work. Unlike insurance, which protects the party obtaining the insurance, surety bonds work to protect the party requiring the bond, as well as the public.
If, for whatever reason, a principal fails to meet their obligations and a claim is filed against the bond, the surety may need to step in and compensate the obligee up to the full amount of the surety bond. In this way, a surety bond works like a line of credit extended to the principal by the surety bond company. Once the claim has been resolved, the principal has to repay the surety for the financial support.
The guarantee extended by surety bonds depends on the type of business you have, and why your business is required to have a bond.
What are some examples of the different types of bonds?
There are three major types of surety bonds:
License and Permit Bonds (Commercial Bonds)
The vast majority of bonds fall into the license and permit bonds category, also known as ‘commercial bonds’. License and permit bonds are part of the licensing requirements for many businesses, such as auto dealers, freight brokers, contractors, collection agencies, mortgage brokers and telemarketers, to name a few. These bonds guarantee that the individuals or businesses abide by the rules and regulations of their business license.
In the case of a claim on a commercial bond, the surety’s coverage is related to mitigating harms that concern violations of the business license, such as fraud, misrepresentation, dishonesty and others.
The most demanded commercial surety bonds are:
Contract bonds guarantee that a construction project will be completed in accordance with federal and state regulations as well as the terms laid out in a construction contract. Bid, performance, payment and supply bonds all fall under the category of contract bonds.
The various contract bonds serve to protect the government (whenever it is awarding a contract) or a private project owner, as well as parties who work with contractors, such as suppliers, laborers and subcontractors.
The most popular contract surety bonds are:
Bid bonds function as security for bids submitted by contractors on a contract. They guarantee that the bidder will execute the contract at the bid price if they are awarded the contract.
Performance bonds guarantee the proper execution of all terms and conditions of an awarded construction contract.
Payment bonds are most frequently required alongside performance bonds and ensure that subcontractors, suppliers and laborers are paid on time and as per the contract.
As you can see, the difference between contractor license bonds and contract bonds is that the former are required during the licensing procedure while the latter are specific to a contract. License bonds need to be renewed annually while contract bonds are valid through the duration of the contract.
Most commonly court bonds deal with an estate or guardianship situation. These bonds typically guarantee to the court that any money involved will be used appropriately.
What's the cost of obtaining a bond?
To obtain a bond, a business needs to pay a fraction of the total bond amount which is called a premium. The amount of the premium is determined on the basis of a number of factors, the most important of those being the personal credit score of the applicant.
For Example, depending on how good or bad the credit score is, commercial bond premium rates fall into two categories - standard market rates, ranging between 0.75%-2.5% of the total bond amount, and high-risk applicant rates, ranging between 2.5%-10% of the total bond amount.
If you have bad credit and have been denied a surety bond, you can still obtain a surety bond through our bad credit surety bond program.
Understanding Bond Claims
It is best to avoid claims on surety bonds. Occasionally, it does happen that a dispute cannot get resolved and obligees file a claim against a principal’s bond.
When that happens, the bond underwriter has to respond by launching a claims investigation. During the investigation, the surety reviews the bond agreement and any evidence of wrongdoing on part of the principal.
If it is established that the claim is legitimate, the surety and the principal must provide compensation within a given timeframe or respond by rectifying the situation, depending on the type of the surety bond.. Even if the surety initially provides the compensation, the principal has the final responsibility to cover all claim-related costs.
You can learn more on our page dedicated to surety bond claims.
How Do I Get Bonded?
The process of obtaining a surety bond can be different based on the type of bond you need
To get a quote for your license bond, you can start your online application here.
Applicants for a contract bond can follow the instructions on our contract bond application.
If you have any further questions, you can also call us at (866)-450-3412 to speak to one of our surety bond experts. For more information on the bonding process, and surety bond requirements, see our how to get bonded page.
Still Have Questions?
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