Table of Contents

Introduction to the Guide

Further down the page you will find the formal definition of what a surety bond is followed by some examples, but we realize that most people searching for “what is a surety bond” are typically looking for an easy understanding of what is being required of them and why; that’s what we are going to tackle first.

what is a surety bond

A surety bond is put in place as a guarantee, a guarantee that you (the Principle) will follow the rules and regulations of your job.

If you have been told you need a surety bond as you apply for your professional license, then the bond is guaranteeing you will abide by the rules and regulations of your license as spelled out by the obligee (for most bonds this is the local, state or federal government; whomever you are applying for a license with).

For contract bonds, the surety bond is guaranteeing you will abide by the specifications set forth in the contract.

How does the surety bond do this? Should you (the Principle) fail to live up to your end of the deal, a claim will be made against your bond. The Surety (Company who is backing your bond) will launch an investigation and if the claim is proven to be valid, they will pay out up to the amount of the bond to make the harmed party “whole” again.

"This sounds just like insurance." It does, doesn’t it? An issue or accident occurs and there’s a payout to correct the situation.

There is one key difference from how a bond works and the insurance payout from say a car accident. While the outcome of an insurance claim may be higher rates, a bond claim will result in the surety looking for reimbursement for all monies paid out. That’s right, instead of viewing your surety bond as insurance; you should look at it like it’s a financial guarantee to the general public. You are essentially putting up an unsecured line of credit out there to guarantee your work.

Read on for a more detailed definition along with some examples on how the different types of surety bonds work.

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Surety Bond Definition

Briefly put, 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:

surety bond obligee

Obligee

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. A good example would be a state DMV requiring an auto dealer to get bonded prior to conducting business.

surety bond principal

Principal

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. To follow the example from the previous paragraph, an auto dealer applying for a license would be the principal in the surety bond agreement.

surety bond company

Surety

The surety (also known as the bonding company) is the party that takes the risk by backing the bond agreement financially up to the full amount of the bond. It provides the financial guarantee in case the principal fails to fullfil their obligations under the agreement. In order to have this guarantee, the principal pays a premium to the bonding company.

Want more details on 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. The maximum compensation cannot exceed the bond's penal sum.

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:

Auto Dealer Bonds

Auto dealer bonds guarantee that motor vehicle dealers will operate in compliance with state regulations for their dealer license. They provide protection for the state and an auto dealer’s customers.

Freight Broker Bonds

It's a federal requirement that transportation brokers need to obtain a $75,000 freight broker bond as part of the licensing process of their business. Freight broker bonds guarantee payment to motor carriers and shippers who do business with a broker.

Contractor License Bonds

Every state has some sort of bonding requirement for contractors. This surety bond ensures compliance with local or state regulations and usually provides protection to people who hire а contractor for a job.

Mortgage Broker Bonds

Mortgage brokers need to get bonded as a requirement for obtaining a business license. Mortgage broker bonds protect customers who work with brokers to obtain a mortgage.

Contract Bonds

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

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

Performance bonds guarantee the proper execution of all terms and conditions of an awarded construction contract.

Payment Bonds

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.

Maintenance Bonds

Sometimes called warranty bonds, maintenance bonds act as a guarantee to the project owner that the contractor will correct faults and defects for a certain period of time after project completion.

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.

Court Bonds

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. Here are some examples:

Appeal Bonds

Appeal bonds are required when somebody wants to appeal a court's decision to a higher court. The bond guarantees that all costs of the initial decision will still be covered in case of an unsuccessful appeal.

Guardianship Bonds

Guardianship bonds are required in some states when a court appoints an individual as the guardian or custodian of another individual.

Fiduciary Bonds

Also known as probate bondes, fiduciary bonds are required when an individual is appointed as a an administrator, fiduciary or trustee.

Fidelity Bonds

This last type of surety bond is the one that actually most closely resembles insurance.

Fidelity bonds are typically not mandatory but many businesses choose to voluntarily obtain them. The reason is that fidelity bonds actually provide protection to business owners in cases such as employee dishonesty, embezzlement and theft. In others, they provide protection to the property of the business' clients.

All of this makes fidelity bonds particularly popular among financial institutions as well as businesses who work on a client's property such as cleaning and home maintenance businesses.

Below are the main types of fidelity bonds:

Business Services Bonds

This is a broad category of fidelity bonds obtained by businesses who have access to their clients' properties. If the business does damage to a client's property, the bond can reimburse the client for their losses.

ERISA Bonds

ERISA Bonds are required of people who handle employee retirement plans. It guarantees their compliance with the Employee Retirement Income Security Act (ERISA).

Employee Dishonesty Bond

This bond is typically obtained by companies in the financial sector. They protect the business from dishonest actions on part of their employees such as theft, forgery, embezzlement and others.

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 depends on the type of bond you need to obtain. It 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.

For extensive information on how surety bond rates are determined, see our surety bond cost guide.

You can also use the our free bond cost calculator to get an estimate on your premium.

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..

About the author:
Todd Bryant
Todd Bryant is a graduate of Germantown Academy and the University of Pittsburgh College of Business Administration Honors College. He has been President of Bryant Surety Bonds, Inc., an A+ rated Business with the Better Business Bureau, since 2007. Licensed as a producer with the Department of Insurance, he has been published in the National Association of Surety Bond Producers newsletter and on numerous authoritative publications such as The Washington Post, Entrepreneur.com, Azcentral.com and many more.

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