Many people haven’t heard of surety bonds, and many who have find them very confusing. This article will help to answer the question: what is a surety bond? In simple terms, this page will explain:
- What exactly is a surety bond?
- Who participates in a surety bond?
- Why do we need them?
- What types of bonds are there?
- How do I get one?
So what exactly are Surety Bonds?
To put it simply, surety bonds are a legally binding contract between three different parties. They make sure that one party (the principal) meets the demands of the other (the obligee). A third party, the surety, guarantees that the principal will fulfill the obligations of the bond. These obligations depend on what type of bond it is and what its purpose is.
If you or your business are in need of a surety bond, then you will be the principal of that bond. The principal is basically the entity that needs the bond to do business or complete a project. Surety bonds might be required to:
- Get certain licenses
- Perform contractual work, such as public construction jobs
- Complete a court proceeding
- Simply protect your business
To the principal, surety bonds are like credit. They are a way for the principal to promise that they will perform their job correctly. If the principal fails to do this, the bond promises this will be taken care of. This means that the bond promises that damages caused by the principal’s mistake will be paid for.
Basically, surety bonds legally promise someone that the principal will perform a task or complete a job lawfully. But who is the principal making that promise to? This party is called the obligee of the bond. Often, the obligee is a legal entity, like a local government or governmental agency. They usually require surety bonds from local businesses or contractors. This protects them and their citizens from “bad behavior” of whoever has the bond.
To the obligee, the bond is like insurance. For instance, health insurance protects your health by paying for a portion of your health care if you need it. In the same way, surety bonds protect the public by paying for damages if needed.
Surety bonds incorporate a third party known as the surety. This party acts as another layer of protection for both the principal and the obligee.
If someone files a claim on the bond, the surety will initially pay the cost of the claim. This agreement protects the principal. However, the principal must pay back the cost of these damages in full at a later date.
Surety bonds must be underwritten before they are given. This is because the surety takes a risk by promising to cover the costs of a claim. The underwriting process is a way to make sure that the principal of the bond is “trustworthy.”
The surety also protects the obligee. By signing the bond, the surety adds another level of security to the agreement. The surety agrees to be liable to the obligee if the principal fails to follow through with the requirements of the bond. If someone files a claim on the bond, the bond guarantees that the surety will be accountable for the fault of the principal.
Not just any entity can be a surety. To become a surety, companies have to undergo a lengthy screening and certification process. This makes sure that the company is qualified and able to accept the liability of the many principals it may sign off on surety bonds for. The US Department of Treasury is responsible for this certification process. It keeps a list of all certified sureties.
If you need a surety bond, you should contact a surety bond agency. They have close connections to many certified sureties. Their experience in the surety world will help you get the bond you need.
What types of surety bonds are there?
There are thousands of different types of surety bonds. Generally, every surety bond falls into two main categories: contract and commercial.
Contract surety bonds are typically required by governmental agencies. True to their name, they apply to contractors and subcontractors. Contract bonds have two main goals:
- Ensuring that contractors complete projects honestly.
- Ensuring that the principal will pay all subcontractors, workers, and suppliers adequately.
Why Are Contract Bonds Required?
So, now we know what contract bonds are, but, why are they required? The short answer is that it’s the law.
If a government agency pays someone to complete a large project, they must trust that contractor. This is because they risk losing a lot of money if that project fails or is not completed well. The federal government passed the Miller Act in 1935 to protect itself from these potential losses. This act applies to the construction, alteration, or repair of any federal governmental building. It requires that all contractors working on these public projects post certain bonds. These bonds add security to the public project process. They ensure that the contractors act honestly and lawfully during the project.
Since the passing of the Miller Act in 1935, state governments have passed similar laws. These laws apply to projects funded by state governments. People commonly refer to these as “Little” or “Baby” Miller Acts. These act very similarly to the federal Miller Act. They require the posting of a payment and/or performance bond for the completion of a public project.
There are three main types of contract bonds required by the Miller Act and Baby Miller Acts:
- Bid Bonds
- Performance Bonds
- Payment Bonds
More information about these contract surety bonds can be found below.
Civil agencies select contractors for projects through a bidding process. During the bidding process, contractors estimate how much they believe the job will cost. The governmental agency that needs the job to be done will choose the contractor based on this information.
But how do government agencies know that the information in the bid is correct? This is why the Miller Act requires bid bonds. Bid bonds protect the obligee from dishonest bids. If the obligee selects a certain bid, the bid bond ensures that the bid represents the real cost of the project.
Once a contractor places a bid and gets chosen for a project, a performance bond is required. The performance bond, as the name suggests, ensures the satisfactory performance of the contractor.
These bonds act as a guarantee that the contractor will complete a job in a certain way. Each bond has its own terms and conditions depending on the type of project and where it is occurring. If the contractor fails to complete the task in accordance with the bond, a claim can be filed. This way, the agency hiring the contractor will not be held accountable if the contractor messes up.
So, the bid bond ensures the bid is honest, and, the performance bond ensures the job is done correctly. There is one last type of liability that must be accounted for: payment. Construction jobs require many laborers, suppliers, and sub-contractors. Because they work with so many people to complete their job, contractors are responsible for paying many different groups. The Miller Act requires the posting of a payment bond to make sure all parties are paid well.
To sum it up, contract bonds are required by the Miller Act and similar Baby Miller Acts. They generally consist of bid bonds, performance bonds, and payment bonds. These bonds all apply to contractors working on public projects and ensure that the contractors will work appropriately.
Contract surety bonds come in many types. However, they are just one category of bonds. That brings us to our next topic: commercial surety.
What is a surety bond? – Commercial Surety
Defined by Variety
Commercial surety encompasses thousands of different types of surety bonds. These bonds range from the Texas Bond for Bingo Prizes to the more traditional California Motor Vehicle Dealer Bond. However, they all share the basic format: principal, obligee, and surety.
Every state has different requirements for bonds and who it requires to be bonded. Often, surety bonds are required to obtain licenses or permits. Sometimes they can be used in other legal cases. One example is registering a vehicle with a lost title. They can also ensure that businesses will pay their state taxes on time.
A few general types of commercial surety bonds are outlined below.
License and Permit Bonds
Surety bonds are often required to obtain a license or permit. When this is the case, they are called license and permit surety bonds. These bonds are a type of commercial surety.
Like most bonds, these surety bonds act as a guarantee to the obligee. They simply make sure that the principal is able to perform its job correctly and lawfully. These bonds are often required by legal agencies and local or state governments. The types of bonds required in any state depend on the laws in that region.
Types of License and Permit Bonds
There are many types of license and permit bonds. A wide variety of business types need to be bonded to become licensed. Mortgage broker bonds and vehicle dealer bonds are some of the most common license and permit surety bonds.
It is important to understand that these bonds do not protect businesses themselves. They protect the public. The bond is a way for the business to ensure that it will conduct itself lawfully. This is why there are so many types of license and permit bonds. The laws and regulations that businesses must follow vary based on what type of business it is. Because of that, every bond must pertain to the specific business that is getting licensed.
Court bonds are another type of commercial surety bond. The term “court bond” generally refers to all types of bonds someone would need in the court of law. There are two main types of court bonds:
Judicial bonds guarantee the court that the principal can pay the cost of all legal actions. Generally, judicial bonds can be divided into plaintiff and defendant bonds. Indemnity to sheriff bonds are a common plaintiff bond. Bail bonds are a common defendant bond.
Fiduciary bonds ensure the court that the fiduciary will act lawfully. If the fiduciary fails to do so, the surety must pay the court and cover the damages. For instance, if a fiduciary commits embezzlement, the surety must pay however much money was embezzled.
How do I get a surety bond?
If you or your business need a bond, it is very easy to get one. Surety bonds are distributed by bond brokers and agents. To get bonded, you first need to apply. After that, the bond agency will contact you and tell you what is needed to get your bond completed.
Typically, bonds require a process called underwriting before they are distributed. The bond underwriter protects the surety. Underwrites decide which accounts can be bonded safely. This lessens the risk for the surety. The underwriter assesses every potential bond account and decides which ones are ready to be bonded.
The underwriting process usually involves a credit check and/or financial statements from previous years. If you are nervous about getting a credit check, check out this blog on how to get a surety bond with bad credit. You can also learn how to raise your surety credit. It is possible to get bonded with a low credit score, and the surety agency will help you do so.
While surety bonds may seem complicated, they are an essential part of safe business operations. If you or your business need a surety bond, contact a surety agency. They are usually well informed and want to help you and your business get the bond that is right for you.
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