What is a Surety Bond?
When faced with a surety bond requirement, many companies and individuals are often not even sure what that product is. A surety bond is a legally binding agreement that guarantees performance, compliance or even payment. It is not considered insurance.
The agreement is composed of three parties: the obligee entity requiring the bond, the principal individual applying for the bond and the surety entity who is issuing bond. In the event that the principal fails to comply with the legal binding agreement as set forth in the bond form, there is monetary compensation to be paid.
How does a Surety Bond work?
A surety bond is put into effect to satisfy the obligee’s requirements, which may range from guarantee against performance, payment or compliance on the local government, state or federal level. There are thousands of different bond types spanning all lines of business. Examples of industries that may be required to obtain bonding include:
- Motor Vehicles Dealers
- Defective or Lost Title Bonds
- Professional Solicitors
- Credit Repair Agencies
- Collection Agencies
- Money Transmitters
- Medical Supply
- Patient Trust
To be considered valid, the surety bond must be issued on the obligee-approved bond form, outlining the obligations in which the principal is beholden. The bond form will outline specific nature of the obligation, bond amount and term of the bond.
A surety bond can guarantee performance, payment or compliance. The contractual aspects that are addressed by the surety bond include:
- Payment Agreements
The purpose of a surety bond is to protect an obligee against losses, up to the limit of the bond, as a result from the principal’s failure to perform its obligation, as set forth in the bond form.
The bond amount is the monetary limit in which the obligee requires the bond to be issued. The bond amount, or bond limit, as it is commonly referred to, is the extent to which monetary compensation is limited.
The aggregate limit in the bond form is verbiage that limits the exposure to not exceed the bond limit. For example, if an obligee requires a $10,000 bond amount, claims cannot exceed the bond limit, which in this case would be $10,000.
The term of the bond is the length in which the surety bond is in effect and is mandated by the obligee. In most cases, it is typically for one year but can vary.
The parties in a Surety Bond:
The surety bond is a three-party legally binding contract.
This is you, your company or institution – the party that gets bonded. As the principal, you agree to perform an obligation that is specified in your surety bond. The principal is ultimately the financially responsible party of the surety bond.
This is the beneficiary – the party that requires you to get bonded. It might be an individual person or an entity such as a company, municipality or government agency. The obligee receives the bond and its protection against loss. The obligee is compensated by the surety in the event that there is a failure in the obligation.
The surety is the carrier whom guarantees that the principal will comply with the obligee’s requirements. It also guarantees that the principal will perform said obligation accordingly and issues the bond on the mandated form. The surety is financially obligated to the obligee in the event that the principal does not meet your obligation.
Types of Surety Bonds:
There are two important categories of bonds: Contract and Commercial. Contract Surety Bonds are job-specific and the obligation is considered satisfactory upon completion of the specific job. Commercial Surety Bonds are bonds required for individuals and/or businesses to guarantee compliance, performance or payment and typically are required continually to meet the obligee’s requirements.
This type of surety bond is often required for construction projects, but are applicable in other contractual agreements. Contract Surety Bonds are written for specific projects. The obligee will seek out a contractor (the principal) to fulfill a contract for a specific job.
Examples of Contract Surety Bonds include:
- Performance Surety Bonds: A performance bond guarantees that a client will perform to the contract terms and conditions as provided by the obligee.
- Payment Surety Bonds: A payment bond guarantees that a supplier and/or subcontractor will be paid per the agreements in hand.
- Bid Surety Bonds: A bid bond provides assurance that the principal will enter into the contract if the project is awarded and will provide the necessary performance and payment bonds
- Maintenance Surety Bonds: A maintenance bond provides guarantees against defects of workmanship on the project within an agreed upon time
Commercial Surety Bonds
Many types of businesses and professionals are mandated to obtain a Commercial Surety Bond to be approved for licensure for compliance. Typically, an entity or individual needs to obtain a commercial bond as part of state licensing requirements. States use commercial bond requirements to ensure that professionals perform work in a legal and ethical manner.
License Surety Bonds
License Surety Bonds, also known as Permit Bonds, are a general type of surety bond that are required for a person or entity to obtain a license or a permit in a city, county or state. They are characterized as statutory, meaning they contain verbiage that references the underlying statutes.
Some common examples of License Surety Bonds are:
- Contractor License Surety Bonds
- Auto Dealer Surety Bonds
- Mortgage Broker Surety Bonds
- DMEPOS (Medicare) Surety Bonds
- Liquor Surety Bonds
- Utility Deposit Surety Bonds
- Auto Dealer Surety Bonds
Motor Vehicle Dealers
Auto Dealer Surety Bonds, which are also commonly referred to as a Motor Vehicle Dealer Bonds or MVD Bonds, are a type of license surety bond that motor vehicle dealers are required to purchase and provide proof of as part of the dealer license application to buy and sell used and/or new automobiles for profit.
Learn more about Auto Dealer Surety Bonds from Pacific Surety.
Some states also require a bond for businesses that sell vehicle parts, salvage dealers, ATV dealers, as well as boat and aircraft dealers.
Sales Tax Surety Bonds
Sales Tax Surety Bonds are a financial guarantee of payment of taxes on products such as tobacco, fuel and liquor. These surety bonds may be required for any business that collects state sales tax along with payment for sold goods.
Learn more about Sales Tax Surety Bonds from Pacific Surety.
Contractor License Surety Bonds
A Contractor License Surety Bond may be required to become a licensed contractor. This bond guarantees that the contractor will abide by all rules and regulations mandated by the state, city or county. Upon receipt of the Contractor License Surety Bond, the obligee will issue the license, allowing the contractor to faithfully perform work for consumers.
Learn more about Contractor License Surety Bonds from Pacific Surety.
Mortgage Surety Bonds
Mortgage Surety Bonds can be required for any individual or entity performing mortgage transactions. This surety bond ensures that the individuals or entity are acting in compliance with mandated rules and regulations. There are multiple types of Mortgage Surety Bond requirements that can include mortgage brokers, mortgage lenders and mortgage loan originators.
Learn more about Mortgage Surety Bonds from Pacific Surety.
Court Surety Bonds
A judge may require someone to obtain a Court Surety Bond before allowing legal proceedings to move forward. Court Surety Bonds hold the bonded party financially liable if they fail to act in a manner as required by the court. Court Surety Bonds are classified into two categories: Judicial and Fiduciary.
Judicial Surety Bonds are required out of legal action to protect an individual for whom a claim may be made for damages, should the “remedy” not come to fruition. Examples of Judicial Surety Bonds include:
- Attachment Surety Bonds: plaintiff bonds which guarantees the payment of damages due to property being attached. This bond will thwart any further use of the property before the court makes their final decision.
- Release of Attachment Surety Bonds: these bonds nullify the attachment bond and guarantee that, should the court decide in favor of the plaintiff, the defendant will pay all damages.
- Appeal Surety Bonds: plaintiff bonds used to appeal a court decision to a higher court and guarantee payment of all court costs.
- Supersedes Surety Bonds: guarantees payment of the total judgment in addition to any interest and court costs.
- Fiduciary Surety Bonds: required by courts for those whom are appointed to faithfully manage the interests of individuals or property.
Examples of Fiduciary Surety Bonds include:
Guardianship Surety Bonds: required for an appointed individual who is legally responsible for the medical care and financial well-being of an individual that is unable to make these decisions for themselves due to age or for medical reasons.
Administrators and Executors Surety Bonds: required by the individual named in a will to carry out the affairs of an estate. If there is no will in place, the court will appoint in individual.
Fidelity Surety Bonds
Fidelity Surety Bonds protect a business and its clients if an employee acts unlawfully. Unlike Commercial and Court bonds, businesses aren’t required to get fidelity bonds, but many consider it a prudent way to manage risk. Fidelity Surety Bonds are considered a form of crime insurance and are characterized by the following coverages:
- Exposure to Loss is Accessible: Employees have the ability to learn routines, habits of fellow employees, and management controls in place or those that may be lacking.
- Hidden Losses: Cover-up of theft may be possible for a period of time. Loss continues to occur at a greater size until discovered, and the loss is considered to be greater the longer a fraudulent act is committed.
- Management Controls: These systems mitigate losses and make fraudulent acts harder to perform. If a fraudulent act is committed, these can also act as a mechanism for uncovering said act.
- Disbelief that employees may be thieves
- Reluctance to prosecute employees who commit fraudulent acts
- Fidelity Surety Bonds also operate like an insurance policy by paying the bonded party, differing from other types of surety bonds that hold the bonded party financially liable.
Who issues a Surety Bond?
Surety bonds are generally issued by surety companies. However, it’s common to apply for a surety bond through a broker or surety bonding agency. These companies must be licensed and regulated by their state to issue bonds.
They can also be issued by banks who obtain them through brokers and dealers who, like insurance agents, obtain a commission on sales.
This is a corporation – usually an insurance company. It can legally underwrite surety bonds.
A firm called a “surety company” guarantees that a business corporation called a “principal” will carry out an obligation to a third party called an “obligee.”
Surety Bond Brokers
A Surety Bond Broker, Dealer or Agency is the licensed surety bond company representative through whom you will obtain your surety bond. Most surety bond companies do not work with surety bond principals directly.
Is a Surety Bond a form of insurance?
Surety Bonds and insurance are not the same. While they are both risk transfer mechanisms that provide for financial loss regulated by state insurance commissions, there are significant differences between surety bonds and insurance.
- An insurance policy is a two-party agreement (insured and insurer), while most surety bonds are three-party agreements (principal, surety and obligee).
- Insurance policies transfer risk from an insured policyholder to an insurer (an insurance company). Surety bonds protect an obligee against losses, not a principal.
- You can buy an insurance policy, but you must qualify for a surety bond. It is a form of credit. A surety company will only take acceptable risks, so it will only bond qualified businesses and individuals.
- Companies that provide insurance expect losses and adjust their insurance rates to cover them. Surety bond companies extend credit, expecting principals to meet the legal obligations of their bonds. They do not expect losses, which severely impact their bottom line. Should losses occur on a surety bond, the principal is required to reimburse the surety for the loss and any additional legal fees incurred.
- Insurance companies calculate assumed losses into policy premiums. Bond premiums include underwriting expenses, such as the qualification of applicants, but do not provide for losses. A bond premium is a service charge. It pays for the financial backing and credit guarantee of a surety bond company, which allows a company or individual to conduct business.
How much do Surety Bonds cost?
The cost of a surety bond depends on multiple factors including type, amount, the state it is being obtained in and a full credit report review of individual applying for the bond. The obligee determines the amount of bond being required, and the amount can vary greatly. While the required bond amount can be high in some circumstances, the actual cost of obtaining the bond is much less.
Commercial Surety Bond costs typically range from 1% – 10% of the amount the bond is written for.
For example, a $50,000 commercial surety bond could cost less than $1,000 depending on the factors indicated above.
Commercial bond premiums are paid upfront at the time the surety bond is obtained and need to be renewed regularly, usually on an annual basis.
Applying for a Commercial Surety Bond:
So, you’ve been required to obtain a surety bond. Now what? By following the three easy steps below, you can successfully apply for a surety bond:
Ensuring that you obtain the correct surety bond at the correct bond amount is imperative.
We always recommend that you have a discussion with the obligee to ensure you have a clear understanding of the bond type and bond amount being required.
We also recommend having your business name and address in place upon applying for the bond.
Ready to get started? Begin the straightforward application process HERE. Once submitted, we will quickly provide a quote.
You will be asked to provide the following:
- Business information
- Who and where the bond is to be issued
- The correct bond and amount
- Business owner information for credit history
Once a quote is received and agreed upon, you will then sign the indemnity agreement and issuance of the bond can occur. After the bond is issued, you will then sign the bond as the principal and file the surety bond with the obligee. When accepted by the obligee, you can consider yourself licensed and bonded.
As the principal, it is your responsibility to renew the bond in a timely manner to prevent a lapse in coverage and remain in compliance with the obligee. Failure to renew your surety bond in a timely manner can result in expensive fees from the obligee and, in some cases, will require re-licensure all together, which can be extremely costly.
About Pacific Surety:
Since 1985, Pacific Surety has been solely focused on surety bonds. As a result of this singular focus, we have become one of the nation’s leading surety bond agencies. This allows us to provide the most competitive bond programs and pricing to our clients, regardless of size or type. Moreover, Pacific Surety is rated A+ by the Better Business Bureau, and we work with only A-rated and T-listed surety companies.
Pacific Surety provides exceptional customer service and competitive rates for a wide range of surety bonds in order to meet the needs of businesses, both large and small. Whether you are a new business, existing company or have had financial or credit problems in the past, Pacific Surety will work with you to develop an innovative, tailored program to fit your surety bond needs. We consider virtually all applicants, both with standard and non-standard credit. We only perform soft credit inquiries when determining premium amounts, so your credit will not be negatively impacted.
Referrals from satisfied clients are our main source of new business. This is a true testament to our commitment to provide exceptional, personalized service regardless of the size of your business.
Some of the customers we serve include:
- Motor Vehicle Dealers
- Mortgage Brokers
- Medical Equipment Suppliers
- Private Trade School Owners
- Many others
Proudly helping businesses throughout the United States, we strive to exceed your expectations.