A Surety Bond is a legally binding agreement that provides a guarantee that a company or individual will deliver on their obligations.
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What is a Surety Bond?
A Surety Bond is a legally binding agreement that provides a guarantee that a company or individual will deliver on their obligations. Surety Bonds help to ensure a company or person will complete the duties it has promised to carry out. There are always three parties involved in a surety bond:
The Principal: The party responsible for meeting an obligation. The principal purchases the Surety Bond to provide a guarantee for their work.
The Obligee: The party that requires a Surety Bond to guarantee that the principal will fulfill obligations.
The Surety: The bond company that issues the bond to guarantee that the principal will fulfill their obligations. If the principal doesn’t meet their obligation, The surety will typically pay out a set amount to the obligee.
- Your company is a software engineering firm that is bidding on a contract to provide a new organizational tool for a federal agency. Since most government contracts require Surety Bonds, your company must first buy a Surety Bond in order to bid on the project.
- Your general contracting firm is bidding on a building project downtown. You purchase a contract Surety Bond that guarantees you will not back out on your bid if you win the contract.
- You are a mortgage broker who will be applying for a license in a state that requires a license and permit bond for you to practice your profession. The bond guarantees that you will abide by the rules and regulations in your dealings with the general public.
Is a Surety Bond an insurance policy?
It’s important to note that Surety Bonds are not insurance policies. Rather, Surety Bonds provide lines of credit. While insurance companies will incur a loss in paying out claims, settlements, or the cost of a legal defense, surety companies do not expect to incur a loss from issuing a surety bond. Surety companies require the principal to sign an indemnity agreement that obligates them to repay the surety company for any costs or losses incurred. The surety company expects to be repaid under the contract signed and can sue the principal if they are not reimbursed.
Why are Surety Bonds needed?
Since Surety Bonds are typically a guarantee of performance, they can help companies secure more business. Moreover, in many cases, government and private contracts will require a Surety Bond in order to participate in the bidding process or upon award of the contract. Securing a Surety Bond may be a basic condition of your company being in the running to win a contract.
In cases where a Surety Bond is not required, getting bonded can help your company stand out from competitors and provide peace of mind to clients that their assets will be protected. With a Surety Bond, your company can demonstrate its financial strength, as there is a rigorous review process in order to secure a bond that not all companies will be able to successfully pass.
Surety Bonds also play an important role in protecting taxpayer dollars from the failure of contractors to deliver on projects. Since the failure of contractors to meet obligations on government projects has been a visible problem for more than a century, the federal government has passed landmark legislation to combat this issue—and virtually all state governments have followed with their own statutes. Today, many government contracts require a Surety Bond. All federal contracts over $100,000 require Surety Bonds and most federal contracts of lesser value also require them. When a company purchases a Surety Bond, it transfers the risk of failure from the government to the surety company.
What are the different types of Surety Bonds?
Contract Surety Bonds
Contract Surety Bonds make a guarantee to owners of construction projects (the obligee) that the contractor (the principal) will meet the obligations of the project. If the contractor fails to deliver the project specifications or engages in harmful business practices, the surety company will find another contractor to complete the project or reimburse the project owner. These are the main types of Contract Surety Bonds:
- Bid Bond: Guarantees the contractor will honor the terms of a bid for a construction project after winning the bid. This protects against instances in which construction companies submit lowball bids and then change the terms of the contract after they are chosen to work on it or back out altogether.
- Performance Bond: Guarantees the contractor will complete the project and adhere to the terms of the contract. In the event of a contractor’s default, the surety company will step in and make the obligee whole.
- Payment Bond: Guarantees the contractor will pay all subcontractors and suppliers for labor and materials provided.
- Maintenance Bond: Guarantees the contractor’s work during the warranty period. The maintenance bond will pay out if defective workmanship or faulty materials result in financial losses for the project owner.
Commercial Surety Bonds
Commercial Surety Bonds include a number of different types of bonds that generally are required by various regulations, ordinances, and entities, including federal, state, and local governments, to protect the public interest, helping to ensure that individuals and businesses adhere to the rules and regulations that protect the public. Commercial Surety Bonds typically fall into the following four categories:
- License and Permit Bonds: Many professionals need to purchase a license and permit bond when they apply for a license, and requirements can vary depending on state regulations. These bonds can apply to such professions as:
- Auto dealers
- Insurance brokers
- Liquor dealers
- Mortgage brokers
- Travel agents
- Court Bonds: These are Surety Bonds that are needed in court proceedings and can serve many different purposes. The two main categories of court bonds include:
- Judicial Bonds: Used in civil court cases to ensure that any costs related to a court’s ruling can be paid for. Common judicial bond types include bail bonds, cost bonds, and attachment bonds.
- Fiduciary or Probate Bonds: Guarantees that the fiduciary, or the person who acts on behalf of another person to manage assets or interests, will lawfully and ethically execute his or her duties under court ruling. Common fiduciary bonds include trustee bonds, guardian bonds, conservator bonds, and administrator bonds.
- Public Official Bonds: For many public officials, there are federal, state, county, and municipal laws that require officials to get bonded. This commonly occurs with positions that are involved in handling public funds, including tax collectors, mayors, and treasurers. Public official bonds serve to protect the public interest and guarantee that the principal will lawfully and ethically perform their official duties.
- Miscellaneous Bonds: There are a variety of Commercial Surety Bonds that don’t fall into one of the categories listed above. Miscellaneous commercial bonds typically come into play through private relationships and support business transactions. Some examples include utility bonds, title bonds, and lost securities bonds.
What is the SBA Surety Bonds Guarantee Program?
The Small Business Administration offers a Surety Bond Guarantee Program to assist small and emerging businesses. Small businesses may struggle to qualify for Surety Bonds sold by surety companies due to a lack of capital, credit, or capacity. The SBA Surety Bond Guarantee Program requires less working capital, which gives more small businesses a chance to qualify for Surety Bonds. Small businesses can qualify for up to $6.5 million on projects to any owner (private, local, state, or federal), and up to $10 million on federal jobs available to prime contractors.
How do Surety Bonds claims work?
You purchase a Surety Bond to guarantee that you will fulfill professional or contractual obligations and pay a premium. If you fulfill the obligations (e.g. complete the project), the bond company will not have to pay out anything. If you do not deliver on all your obligations as agreed upon, the obligee can file a claim against your Surety Bond. The bond company will investigate the claim to determine whether you are responsible for the failure to meet obligations and pay out the claim accordingly if it is judged to be valid. However, unlike insurance policies, you will be expected to reimburse the surety company at some later date.
For any project or profession, there is always the risk that the work will not be completed in a satisfactory manner. In general, Surety Bonds provide a guarantee that the insured party will meet obligations. If the obligations are not met, then the Surety Bond will pay out a sum to the project owner. Surety Bonds can help businesses seeking to win a contract reassure the owner that it will deliver on expectations. Since many government contracts also require Surety Bonds, they play an important role in ensuring that taxpayer dollars are not wasted on failed projects. Surety Bonds are also required for many professionals before they can obtain a license in order to ensure that they will adhere to rules and regulations that protect the public interest.