SURETY BOND: All You Need To Know

Surety bond
Granite Insurance

A surety bond is sometimes necessary for a business to guarantee that the task they are hired to execute will be completed. Each surety bond must be individually crafted to satisfy specific requirements.

What Does a Surety Bond Mean?

A surety bond (pronounced “shur-ih-tee bond”) is a written agreement that guarantees the compliance, payment, or completion of an act. Because it entails a three-party agreement, it is a surety is a unique sort of insurance. A surety agreement has three parties:

The principal is the party who purchases the bond and agrees to perform an act as promised.

  • Surety – the insurance or surety company that guarantees that the obligation will be met. If the principal fails to complete the act as promised, the surety is contractually obligated to make up the difference.
  • Obligee (pronounced obb-li-jee) – the party who requires a surety bond and typically benefits from it. The obligee for most surety bonds is a local, state, or federal government institution.

Types of Surety Bond

The surety bond definition includes multiple types of surety bonds that are utilized in various scenarios. Most of them have a few characteristics:

  • Bonding capacity: The highest amount of bonding that a principle can get. The contractor’s working capital, cash flow, and managerial experience all play a role.
  • Working capital: Sureties typically require principals to have a certain amount of working capital, which is defined as current assets less current liabilities. Depending on the size of the principle, the requirement is usually between 5% and 10% of the entire bonded amount.
  • Bond premium: A cost levied by the surety that is normally 1% to 15% of the bonded amount and is typically paid in advance by the principal for the whole term.
  • Bond period: A surety bond typically has a term of one to four years and can be renewed if necessary.

#1. Contract Surety Bond

A contract surety bond is often used to ensure a contractor’s (in this example, the principal’s) performance under a construction contract. If the contractor fails to complete the project, the surety firm must find another contractor or reimburse the project owner for any financial losses. Certain forms of contract surety bonds can be guaranteed by the SBA.

A contract bond’s cost is normally based on the contract amount and can range from 0.5% to 3% of the contract price. During the underwriting process, surety underwriters will assess the contractor’s character, cash flow, credit score, and work history.

Contract surety bonds are classified as follows:

  • Bid Bond: ensure that a contractor will meet the specifications in the bids they submit and will not back out of a bid they’ve won.
  • Performance Bond: A performance bond protects an obligee in bond if a contractor fails to complete a job on time. These bonds are frequently linked to bid bonds.
  • Payment Bond: It ensures that the contractor will pay its subcontractors, employees, and material suppliers in accordance with the terms of the contract. Most significant government and commercial building projects require this sort of bond.
  • Maintenance Bond: These also known as warranty bonds, safeguard the project owner from losses caused by faulty materials or poor workmanship on the building project. A standard term of one to two years is used.

#2. Commercial Surety Bond

Governmental entities require a commercial surety bond to defend the public interest. These bonds are often employed by licensed firms to assure compliance with all legislation and codes pertaining to the general public’s well-being. Licensing contractors, automotive dealers, lottery ticket vendors, liquor stores, notaries, and licensed professionals are examples of typical principals.

Commercial surety bonds come in a variety of forms, including:

  • License and permit bonds: Government entities require licensing and permit bonds when professionals apply for a license. Pipelayers, electricians, and contractors are examples of common principles.
  • Mortgage broker bond: This sort of bond protects borrowers from mortgage brokers’ improprieties and ensures that mortgage brokers follow state requirements.
  • Other types include: Liquor companies, utilities, warehouse companies, auctioneers, lottery ticket sellers, auto dealers, fuel marketers, travel agents, and agricultural companies all require specialized commercial surety bonds.

#3. Fidelity Surety Bond

Companies purchase fidelity surety bonds to protect themselves against employee dishonesty and theft. They are essential for companies that deal with pricey things or significant sums of money. Credit unions, for example, may obtain a fidelity bond that covers them if an employee takes $10,000 by faking a loan. Businesses, as well as current, former, and temporary workers, directors, trustees, and partners, are all covered by fidelity surety bonds.

Fidelity surety bonds are classified into three types:

  • Business Services Bond: Employee theft or damage to client and customer assets, such as money, personal belongings, and supplies, is protected by a business services bond.
  • Employee dishonesty bond: This sort of bond protects a company from damages caused by dishonest personnel. Nonprofit groups frequently use it.
  • ERISA bond: ERISA bonds are required by institutional investors and pension programs to protect participants from mismanagement of retirement plans by employees.

#4. Court Surety Bond

Court surety bonds safeguard individuals or companies from financial losses during court proceedings. Both plaintiffs and defendants, as well as estate managers, commonly use these. Typical examples include:

  • Cost Bonds: guarantee the payment of court fees during litigation.
  • Administrator Bond: This sort of bond assures that an estate’s administrator fulfills their court-appointed duties. It is commonly employed when the estate’s owner died without a will or did not choose someone to carry out the will.
  • Guardianship Bonds: This ensures that guardians will operate in the best interests of incapacitated people and kids.
  • Attachment Bond: Courts are required to have them before seizing someone’s property, as they promise that defendants will be compensated for any damages incurred as a result of the seizure.

How Long Does Getting a Surety Bond Take?

Bonding is a quick and straightforward process that may be completed in as little as a day or two when you work with an expert surety business. Larger bonds, as well as payment and performance bonds, frequently necessitate more processing time.

Benefits of a Surety Bond

Surety bonds are frequently employed for their advantages over other bond options. Some obligees permit you to post cash instead of a bond, usually in the form of a single lump-sum payment to a custodian or trustee that is held in reserve to satisfy claims. A letter of credit may be posted instead of a surety bond in some instances.

Read Also: WHAT ARE BEARER BONDS: Definition and How It Works

Surety bonds, on the other hand, have several advantages over these bond alternatives, including:

  • Non-Asset Collateral – Because the surety offers the guarantee, you do not have to utilize your assets to make the guarantee. For example, if you have a claim to pay and paid the upfront cost with a mortgage, the financial institution will use your property as collateral if you are unable to pay through other means. Surety bonds can assist you in avoiding asset seizure situations.
  • Lower Costs – While using an alternative saves you the cost of the bond premium, you face other problems. For example, posting cash as your bond could result in a loss of investment earnings, even from a somewhat conservative portfolio. In most circumstances, this is a more significant financial burden than the expense of a surety bond.
  • Increased Capital Posting your own assets, such as cash, instead of acquiring a bond reduces your liquidity. This may make future loans or big expenses more difficult to obtain. Furthermore, a lack of cash reserves may result in your company defaulting on a contract or becoming bankrupt.
  • Claim Inquiry – When a claim is made against a bond, a surety must conduct an investigation. When you deposit assets or cash to satisfy an obligee’s requirement, this is not always the case. Because you do not have claims advocates on your side, you may mistakenly pay for claims that are not genuine while employing an alternative to a bond.

Example of a Surety Bond

In the case of contractors, here’s an example of how a surety bond is employed.

Need for a bond

Assume a business owner (the principal) has recently relocated to Georgia and wants to establish a small construction business. He decides to become a general contractor. However, the State of Georgia (the obligee) requires a general contractor license to engage in building contracts worth more than $2,500. One of the many requirements for obtaining this license is a $25,000 contractor surety bond, which serves as a financial guarantee.

Obtaining a Bond

A surety company is used by the business owner to get a bond (the surety). A short underwriting process determines how risky somebody is based on characteristics such as his credit score, financial documents, previous bond history, and moral character. This business owner is an outstanding candidate and receives a surety bond premium of 2%, which means he pays a fixed charge of $500.00 to the lender to obtain the bond.

Bond Claim Form

The application of the business owner is successful. They now have a General Contractor Limited Tier License, which allows them to take on projects for up to $1,000,000. Half a year later, it is discovered that his handiwork on a residential home is defective. It is not the standard agreed upon in his contract with the project owner. The project owner makes a claim on the bond. The investigation concludes that the business owner failed to meet their contractual responsibilities, so the surety compensates the project owner. The business owner is now responsible for repaying the surety.

How to Get a Surety Bond

The requirements for obtaining a surety bond vary depending on your city, county, and state. In order to obtain a surety bond, you must first understand what form of bond a specific obligee demands and in what amount. After that, you should contact your independent insurance agent to learn how to apply for a surety bond. They will walk you through the procedure, which will comprise the following steps:

  • Evaluation and qualifying – You will be needed to present financial documentation to verify your creditworthiness and your ability to meet the terms of the surety bond. You must also give information on the project that will be covered by the bond.
  • Underwriting – Travelers will evaluate your risk in order to bond you and may issue a legal agreement requiring your indemnity in the case of a loss, as well as other required duties.
  • Bond issuance – you will be given a surety bond to sign and deliver to the other party (Obligee)

How Much is a Surety Bond?

A surety bond’s cost (known as the premium) is determined by a number of factors, including the bond type, length of coverage, risk, the principal’s credit score and past claims history, financial capacity, and other factors. The surety bond premium can vary depending on this information.

Each state and its governing bodies establish its own surety bond requirements. The obligee will notify you if a bond is required, the type of bond, and the amount of coverage.

Find a local independent agent to learn more about surety bonds and to receive a price for a surety bond program that is appropriate for your company or project.

When is a Surety Bond Required?

Contractors seeking to work on high-value government projects are often required to post surety bonds. Even if they are not mandatory, surety bonds are useful when a contract requires performance because they reimburse obligees when principals fail to meet their contractual commitments. Before extending funding in the construction business, some lenders may demand the project be bonded.

Is It Possible To Cancel a Surety Bond?

There are various reasons why you might need to cancel a surety bond, such as deciding not to obtain a required license for your firm or obtaining the incorrect bond type. The procedure for canceling a bond varies by state, however, it is normally accomplished in one of the following ways:

  • The surety sends the principal a cancellation notification outlining the terms of the cancellation.
  • Some bonds, such as term bonds, automatically expire after their maturity date.
  • The obligee sends a written notice approving the bond’s cancellation.
  • The original bond is returned to the surety by the obligee.

The technique varies depending on the type of bond. A financial guarantee bond, for example, requires the obligee to sign a letter agreeing to the cancellation. A court bond, on the other hand, necessitates the signing of a legal affidavit by the judge.

Reimbursement for a surety bond after cancellation is uncommon, however, it is available for some companies. In some situations, the principal may be eligible for a partial or complete refund. Before agreeing to a surety bond, inquire about the surety company’s cancellation and return policy. When you cancel an SBA-guaranteed bond, the SBA returns the guarantee cost and you will not be charged any further fees.

Where Can I Get a Surety Bond?

Surety bonds are often underwritten by insurance firms’ subsidiaries or divisions. Working with a surety bond provider who also works with surety bond manufacturers may be advantageous. These licensed business professionals are well-versed in surety goods. The SBA has approved surety bond partners such as Nationwide Mutual Insurance Company, Liberty Mutual Surety, and Zurich Insurance Group.

As previously stated, the SBA provides a guarantee program to help principals secure contract surety bonds when they might otherwise have difficulties.

Surety Bond FAQs

Are surety bonds a good idea?

Obtaining a surety bond is an essential yet perplexing component of the process in many companies. Surety bonds are beneficial to businesses. They instill trust in your firm, increase its reputation, and, in most cases, keep it in compliance with the law or the governing body of your industry.

Does a surety bond affect your credit?

Credit checks for bonds are not as intrusive as credit checks for vehicle payments or mortgage loans. Most credit reviews for bonds only require a light draw, which means your credit score will be affected for a brief period of time.

What is a good credit score for a surety bond?

Surety bond companies prefer credit ratings above 670 and the absence of collections, liens, and judgments. If your credit score is less than 670, that’s usually fine; you’ll just have to pay more for your bond.

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