What Is A Surety Bond? All You Need To Know

A surety company uses bonds to promise payment to the primary client if the obligatory party doesn’t meet their commitment. In this scenario, the formula works as follows: 

  1. The principal party is the individual responsible for following through on the commitment. 
  2. The obligee is the person needing a guarantee that the principal will meet their obligation. 
  3. The surety supplies the bond to guarantee the duty will be met. 

In the most straightforward terms, the surety bond, click here for details, ensures that the surety pays the obligee decided upon funds if the principal doesn’t perform the agreed-upon commitment. 

In many cases, the obligee is a government-appointed agency, but professional or commercial entities also serve in this role.  

Surety bonds allow small contractors to compete for contracts by reassuring the client the service will be as described in the quote. The principal will pay the surety, often an insurance carrier, a premium to secure the bond, which requires an indemnity agreement from the principal.  

This says that personal assets will be used to compensate for a surety if a claim is brought. The surety will satisfy its own claim if these assets don’t meet the reimbursement. When is a surety bond needed? 

Surety bonds are usually needed when contractors work with high-revenue government contracts.  

This makes sense when performance is a priority since the bond will reimburse the obligee if the principal doesn’t meet the contractual obligation. Some Lenders won’t extend financing on the project unless it is bonded first. 

Learn about surety at https://www.investopedia.com/terms/s/surety.asp. Look more closely at the different types of surety bonds. 

What Are The Types Of Surety Bonds 

Different types of surety bonds are used for varying situations. In general, there are common denominators for all surety bonds, including the following: 

  1. Term: The term for a surety bond generally ranges up to four years, with the potential for renewal if necessary. 
  2. Premium: Fees ranging up to 15 per cent of the surety amount charged are usually paid upfront by the principal for a whole term 
  3. Capital: Usually, sureties require principals to have a certain amount of “assets minus liabilities” or capital. It will depend on the principal size, but it typically ranges as high as 10 per cent of the bonded amount. 
  4. Bond capacity: The principal can obtain a max bond amount based on managerial experience, cash flow, and working capital.

a. A contract bond 

The contract surety bond will help to guarantee a contractor’s performance, referred to as the principal for a construction contract.  

If the contractor doesn’t meet the contract terms, the surety company must secure a principal that will finish based on the contract obligations or reimburse for financial losses incurred. The contract bond cost is usually based on the contract price ranging roughly up to as much as 3 per cent of that price.  

The surety underwriters take into consideration the contractor’s cash flow, credit rating, character, and work history in their process. Click here for guidance on surety bonds for business owners.

b. Commercial bond 

The commercial surety bond is one government bodies require to protect the public interest. Licensed businesses generally use these to ensure they meet the codes and regulations in the general public’s best interests.  

Standard principals are notaries or licensed professionals, licensed contractors, lottery ticket sales, and auto dealers.

c. Fidelity bonds 

A company will buy fidelity bonds to protect its interests from dishonest staff and potential employee theft. These are essential for businesses that work with high volumes of cash or valuable inventory.  

Credit unions might benefit from a fidelity bond to offer protection if a staff member were to “invent” a false loan ranging in the thousands of dollars. The bonds can be set up to protect staff, whether previous, current, or temporary, the business, executives, partners, and stockholders.

d. Court bond 

When experiencing a loss during a court case, the court surety bond protects individuals and businesses in the legal system, whether a plaintiff or a defendant. With a “cost bond,” the court fees are guaranteed during litigation, plus there are other variations to benefit clients having challenges with the law.

Final Thoughts 

A surety bond, in essence, is a written agreement that guarantees a standard of performance, payment, or compliance. It’s a sort of distinct insurance between three parties involving the principal, obligee, and surety.  

The contract bond guarantees that a contractor will finish their project following the agreed-upon project guidelines and compensate vendors and subcontractors.  

If that isn’t the case, the surety will need to make restitution for the failed contract, and the contractor will need to reimburse the surety if there’s no logical cause for failure to meet the obligation. 

Many surety bonds are made for a set term of up to three years or a continuous term, meaning they are enforced until cancelled. Many state contractor bonds are issued as continuous bonds. California is among the states with the most surety bond requirements.

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