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When Do You Need A Surety Bond?

Mar 10

A surety bond is a legally enforceable contract that guarantees that commitments will be honored — or, in the event of failure, that compensation will be paid to make up for the missed duties. Surety bonds can be used to guarantee the completion of government contracts, pay damages incurred as a result of a court dispute, or safeguard a corporation against employee dishonesty.

What is the definition of a surety bond?

A surety firm promises to reimburse a first party if a second party fails to satisfy its obligations. There are three parties involved:

  • The principal is the one who is responsible for fulfilling a commitment.
  • The obligee is the individual who need assurance that the principal will fulfill his or her obligations.
  • The surety is the company that issues the surety bond and guarantees that the principal will fulfill his or her obligations.

What is the purpose of a surety bond?

A surety bond, at its most basic level, obligates the surety to pay a specified sum of money to the obligee if the principal fails to fulfill a contractual duty. Surety bonds are widely used by government entities, but they can also be used by commercial and professional parties. Surety bonds assist principals, who are often small contractors, in competing for contracts by ensuring that consumers will get the goods or service provided.

The principal pays a premium to the surety, which is usually an insurance company, in order to secure a surety bond. The principle must sign an indemnification agreement pledging company and personal assets to compensate the surety in the event of a claim. If these assets are inadequate or uncollectible, the surety must pay the claim with its own money.

Small Business Administration (SBA) role: For a charge of 0.60 percent of the contract value, the SBA Surety Bond Guarantee Program insures numerous types of contract bonds. On contracts up to $10 million, if the principal fails to satisfy contractual commitments, the SBA will compensate the surety for a portion of its losses (up to 90%).

Surety bonds come in a variety of shapes and sizes

The term "surety bond" refers to a variety of distinct forms of surety bonds that are used in various contexts. Most of them have a few characteristics:

  • A principal's bonding capacity is the greatest amount of money he or she may borrow. The contractor's working capital, cash flow, and managerial experience all play a role.
  • Sureties often require principals to have a certain level of working capital, which is defined as current assets minus current liabilities. The requirement varies depending on the size of the principle, but it is usually between 5% and 10% of the entire bonded amount.
  • Premium on bonds: The surety charges a fee ranging from 1% to 15% of the bonded amount, which is usually paid up advance by the principal for the full period.
  • A surety bond typically lasts one to four years and can be renewed if necessary.

Surety bond for a contract

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

A contract bond's cost is usually determined by the contract amount, and it normally ranges from 0.5 percent 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.

The following are examples of contract surety bonds:

  • Bid bonds ensure that a contractor will be able to satisfy the parameters in the bids they submit and will not back out of a bid that they have won.
  • A performance bond protects an obligee in the event that a contractor fails to execute a job on time. These bonds are frequently linked to bid bonds.
  • Payment bonds ensure that the contractor pays its subcontractors, employees, and material suppliers according to the contract's terms. Most significant government and commercial building projects require this form of bond.
  • Maintenance bonds, also known as warranty bonds, safeguard the project owner against losses caused by faulty products or poor workmanship on the building site.
  • A usual term lasts between one and two years.

Surety bond for business

Government institutions require a commercial surety bond to defend the public interest. Licensed firms often utilize these bonds to guarantee that they follow all rules and codes that pertain to the general public's safety. Licensed contractors, automotive dealers, lottery ticket vendors, liquor stores, notaries, and licensed professions are examples of typical principles.

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

  • Government entities need licensing and permit bonds when professionals seek for a license. Pipe layers, electricians, and contractors are examples of typical principles.
  • Mortgage broker bond: This sort of bond protects borrowers against mortgage brokers who commit fraud and guarantees that they follow state requirements.
  • Other kinds include: Liquor stores, utilities, warehouses, auctioneers, lottery ticket vendors, car dealers, gasoline sellers, travel agencies, and agricultural businesses all require specialized commercial surety bonds.

Surety bond for fidelity

Fidelity surety bonds are purchased by businesses to protect themselves from employee theft and dishonesty. They're crucial for businesses that deal with high-value commodities or huge sums of money. For example, credit unions can get a fidelity bond that covers them if an employee steals $10,000 by inventing a fictional loan. Businesses, as well as current, former, and temporary workers, directors, trustees, and partners, are covered by fidelity surety bonds.

Fidelity surety bonds come in three varieties:

  • Employee theft of or damage to client and customer assets, such as money, personal items, and supplies, is protected by a business services bond.
  • Employee dishonesty bond: This sort of bond protects a company from damages caused by dishonesty on the part of its workers. Nonprofit groups frequently utilize it.
  • ERISA bond: ERISA bonds are needed by institutional investors and pension programs to safeguard participants from mismanagement of retirement plans by workers.

Surety bond for the court

Court surety bonds safeguard individuals and businesses from financial damages during court proceedings. Both plaintiffs and defendants, as well as estate managers, commonly employ these. The following are examples of common types:

  • Cost bonds ensure that court fees are paid during the course of the case.
  • Administrator bond: This sort of bond assures that the executor of an estate carries out their court-ordered responsibilities. When the estate's owner died without a will or did not name someone to carry out the will, it is usually utilized.
  • Guardianship bonds ensure that guardians operate in the best interests of disabled individuals and kids.
  • Attachment bond: Courts must acquire them before seizing a person's property because they ensure that defendants will be compensated for any damages caused by the seizure.

When is a surety bond required?

Contractors seeking to work on high-value government projects are frequently asked to post surety bonds. Surety bonds make sense when a contract demands performance, even though they are not mandatory, since they help recompense obligees when principals fail to satisfy their contractual commitments. Before extending funding in the construction business, certain lenders may demand the project to be bonded.

Is it possible to terminate a surety bond?

You may need to cancel a surety bond for a variety of reasons, including failing to secure a required license for your firm or receiving the incorrect bond type. The method for canceling a bond varies by state, but it usually involves one of the following steps:

  • The surety sends the principal a cancellation notice that spells out the terms of the cancellation.
  • Some bonds, such as term bonds, automatically expire when their maturity date approaches.
  • The obligee gives written notification that the bond is being canceled.
  • The obligee is responsible for returning the original bond to the surety.
  • The procedure varies depending on the type of bond. A letter from the obligee agreeing to the cancellation of a financial guarantee bond, for example, is required. A court bond, on the other hand, necessitates the signing of a formal affidavit by the judge.

It's unusual to get a return for a surety bond after it's been canceled, but it's feasible in some cases. In some situations, the principle may be eligible for a partial or complete return. Before committing to a surety bond, make sure you inquire about the cancellation and refund policies of the surety firm. When you cancel an SBA-guaranteed bond, the SBA will refund the guarantee price and you will not be charged anything else.

Where can I obtain surety bonds?

Surety bonds are often underwritten by insurance company subsidiaries or divisions. Working with a surety bond provider who also works with surety bond manufacturers might be useful. These qualified business experts have a thorough understanding of surety products. The SBA has recognized Nationwide Mutual Insurance Company, Liberty Mutual Surety, and Zurich Insurance Group as surety bond partners.

As previously stated, the SBA provides a guarantee program to assist principals in obtaining contract surety bonds where they might otherwise encounter challenges.