What is a Surety Bond and When Do You Need One?
Before we go answering the question What is a Surety Bond? let get these facts fixed. Federal, state, and local governments require surety bonds in order to manage risk on construction projects and protect taxpayer dollars. However, surety bonds are not limited to public work. Many private project owners stipulate bonding requirements on their projects, as a result, prime contractors may require subcontractors to obtain bonds.
In today’s competitive construction environment, a contractor’s ability to obtain surety bonds has a significant effect on that contractor’s ability to acquire work. So, let’s delve deep into what Surety Bonds really is.
But before that, here is what the post covers:
- Firstly, What is a Surety Bond
- How does a surety bond work
- Types of Surety Bonds
- Next, When Do You Need a Surety Bond
- How to Get a Surety Bond
- Also, How do I calculate the cost of Surety Bonds
- What is surety bond underwriting
- Where to Get Surety Bonds
- Finally, References
What is a Surety Bond?
A surety bond is defined as a three-party agreement that legally binds together a principal who needs the bond, an obligee who requires the bond, and a surety company that sells the bond. Yes! The bond guarantees the principal will act in accordance with certain laws. If the principal fails to perform in this manner, the bond will cover resulting damages or losses. That is how it works.
How does a surety bond work?
To start with, a surety bond isn’t an investment like corporate bonds. That is to say, a surety bond is sometimes required for certain contracts or transactions. That said, it is a guarantee issued by an insurance company or financial house, that a contract will be complete as promised. It is a legal doc.
as a result…
First, take, for example, if you are a contractor doing work for the government, you should have a surety bond. As a result, the bond protects the government if you fail to do the work as promised. It covers up for such a case.
In detail, let’s say you promise to build a school and fail to finish it, the surety bond would pay to complete the school. Not only but also, the insurance company that issued the bond would have to pay for the work you didn’t do. Hope it is clear now?
Second, for instance, assuming you bid on a job to repair a city government building, you might be required to have a surety bond. Also, if you took some of the money, but did not repair the building properly. As a result, the city government could get the insurance company which issued the surety bond to reimburse her for the expense.
Types of Surety Bonds
There are a few types of surety bonds. However, for easy reading, I will break them into three categories.
#1: Contract Surety Bonds
Contract Surety Bonds otherwise called Bonds for contractors are required by (but not limited to) government and private bodies and even personal.
That said, contract bonds guarantee the performance of a contract. Thus, these bonds are always used in the construction industry and are often called construction bonds.
Again, this category includes a few different types of bonds including performance bonds. Next, payment bonds, bid bonds, supply bonds, maintenance bonds, subdivision bonds. Next, site improvement bonds, completion bonds, warranty bonds, and service contract bonds.
In sum, all of these bonds guarantee that the contractor will complete a project on time, within budget, and according to the contract spec. More so, most of these bonds also include a payment bond that guarantees subcontractors and suppliers that provide labor and materials for the project are paid when the project is completed.
#2: Commercial Surety Bonds
Commercial Surety Bonds otherwise called Non-contract bonds are generally required by federal and/or provincial courts. Also, government bodies, financial institutions, and private corporations – further, licensed contractors. It is also needed by automobile dealers, lottery-ticket sellers, liquor stores, notaries, and licensed professionals.
Non-contract bonds guarantee the performance of an obligation that does not arise from a contract. Again, there are a few different types of non-contract bonds. These bonds are often called commercial bonds and include license and permit bonds, tax bonds, public official bonds, miscellaneous bonds, and court bonds.
Furthermore, estate Bonds, Customs and Excise Bonds, Lost Document Bonds, Mortgage broker bond, License and permit bonds, etc.
#3: Developer Surety Bonds
Developers Bonds can be posted instead of cash for financial security requirements imposed on developers throughout their projects. Take for instance, in condominium developments, Tarion Bonds and Condominium Deposit Insurance are beneficial products to put in place at the start of the project. More so, subdivisions Bonds are an excellent alternative to a Letter of Credit for subdivision developments.
Minor Bonds Types
License and permit bonds – are statutory, meaning they are required to be posted by federal, state, or local statutes. So, these bonds are required to be posted before a municipality will grant a license or permit to conduct business in certain industries.
Tax bonds – are also statutory and guarantee that the principal will account for and pay all taxes due to the federal, state, or local government. Some examples include liquor, tobacco, sales, and fuel tax bonds.
Public official bonds – guarantee that public officials perform their duties honestly and faithfully. Depending on the language in the statutes. Also, public officials can be held personally liable for damages, losses, and shortages to public property.
Miscellaneous bonds – include the vast number of bonds that don’t fall into any other category. These can include lost securities bonds, credit enhancement financial guaranty bonds, and hazardous waste removal bonds.
Court bonds – protects individuals or companies from losses during court cases. It’s further broken down into judicial bonds and fiduciary bonds.
Judicial bonds – are guarantees required by the courts at significant points in the litigation process to protect the opposing party in the event that the principal does not prevail in court.
Judicial bonds are posted by plaintiffs and defendants and include attachment bonds (release attachment bonds for defendants). Next, replevin bonds (counter-replevin), injunction bonds (dissolve injunction), and garnishment bonds (release of garnishment). Next, appeal bonds, Lis Pendens Bond, supersedes bonds, and release of lien/transfer of lien bonds.
Fiduciary bonds – are also called probate bonds. These bonds are used under a wide range of circumstances and generally guarantee that those appointed by the court to care for others’ property will exercise their duties faithfully. Or be held personally liable.
These bonds include administrator bonds, personal representative bonds, and executor bonds. Next, trustee bonds, guardianship bonds, conservator bonds, receivers bonds, assignee bonds. Next, examiners bonds, and bonds in place of probate.
Fidelity bonds – are a form of insurance protection that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees. These bonds include ERISA bonds, business service bonds, and dishonesty bonds that come in the form of blanket coverage or scheduled coverage. Fidelity surety bonds cover businesses, current, former, and temporary employees, and directors, trustees, and partners.
When Do You Need a Surety Bond?
Yes, you sure need a surety bond especially if you must work on government contracts and other government-licensed companies and organizations. But even at that, when engaged in the development of personal projects as an individual or private organization. Also if the project requires lots of money as well as performance and delivery. You need bonding to save you from unforeseen challenges that may arise.
How to Get a Surety Bond
After determining the type of bond you require, you need to then understand what the requirements are in your specific area. For your information, different countries, states, and cities may have different surety bond requirements based on your profession or business. If you purchase the incorrect bond because you do not take a close look at these specific requirements, the obligee will not accept the bond.
So you will need to do the following to secure surety bonds…
- Firstly, Contact your state or local licensing authority or the obligee requesting the bond to ask which category of bond you need, and in what amount
- Use a well-known bond analysis tool some for free and others paid to determine which bond you need
- Finally, Contact a bond agent directly for assistance with figuring out your specific bond needs
To further refresh your memory, surety bonds are legally binding contracts that ensure obligations will be met between three parties:
They oblige – the party who is the recipient of an obligation
The principal – the primary party who will perform the contractual terms
The surety – who assures the obligee that the principal can perform the task
How do I calculate the cost of Surety Bonds?
Surety bonds come in all shapes and sizes. They are usually written for a small percentage of the total bond amount, typically between 1% and 5%. This rate is known as the premium in the surety industry and is generally charged on an annual basis.
Many factors contribute to the cost of a surety bond. Some bonds can be written with just a personal credit check. While others require much more information, including personal financial statements, corporate financials, and industry experience.
In essence, it’s difficult to calculate the cost of anyone bond since there are so many different bonds out there and everyone has a different credit/financial situation. If you are working on a project that requires bonding. It is best to contact a reputable surety bond agent before you invest too much time or money into the project. A good surety agent will be able to discuss what is needed for the bond and how much it could cost.
In sum, the costs of surety bonds depend on many factors, including the surety’s premium filings with each state’s Department of Insurance. More so, the financial strength of the principle, the type of bond being requested, what work is being guaranteed, etc.
That said, here are a few things you need to check when calculating or trying to get bonded or surety for bonds.
Bonded Amount – Sureties typically cap the bonded amount at 10 to 15 times the principal’s business equity. Thus, which is the amount invested in the company plus retained earnings. Sureties generally have an absolute cap on the bonded amount.
Working Capital – Sureties usually require principals to have an amount of working capital. That is, current assets minus current liabilities. Equal to at least 10% of the total bonded amount.
Bonding Capacity – The maximum bonded amount a principal can obtain. It is a function of business equity and working capital.
Bond Premium – A fee of 1% to 15% of the bonded amount charged by the surety and paid by the principal annually.
Bond Term – A surety bond usually has a term of one to four years. Some are perpetual, with no expiration date.
What is surety bond underwriting?
In general, surety bond underwriting is the process of determining an entity’s (person or company) bondability. It is similar to the underwriting done when applying for a mortgage. In the case of bonding, the surety company needs to determine if the applicant is capable of fulfilling their end of the contract. The amount of underwriting done is determined by the type of bond and the risk associated with that bond.
Take, for instance, non-contract bonds (license and permit bonds) are generally underwritten using the applicant’s credit score. In some situations, the surety company may ask for more information, including personal financial and/or corporate financials. For contract bonds (think construction bonds or payment and performance bonds) valued over a few hundred thousand dollars the process is much more in-depth.
The surety company will not only review your credit reports, personal financials, and corporate financials. But they will also review your work history and experience, banking relationships, credit references. Next, accounting information, banking information, contact references, and other types of information and documents related to you and your business.
For your information, the predominance of underwriting large surety bonds is focused on work experience and corporate financial statements.
Where to Get Surety Bonds
The U.S. Small Business Administration is a United States government agency that provides support to entrepreneurs and small businesses. That said, Surety bonds are no other but insurance policy, law, agreement, or regulatory term offered by insurance companies on products and services. In sum, you can turn to Travelers Bond, Liberty Mutual Group, and Zurich Insurance Group to get a Surety bond. That said, where to get a surety bond depends on what you want to bond. Or the type of bond needed.
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