What is a Surety Bond? A Beginner’s Guide.
A surety bond is a legally binding contract ensuring that one party keeps its promise to another. If someone fails to keep their promise, a surety company will compensate the party who experienced the loss. Then the party at fault for breaching the contract will have to pay the surety back.
Confused? Hey, that’s okay! That’s what this article is for – to guide you through the basics of surety bonds and explain exactly how these contracts work for everyone involved. By the end, you should understand why surety bonds are necessary and when you might need one.
Surety Bond Definition
Three different parties are involved in surety bonds: the principal, the obligee, and the surety.
1. Principal
The principal is the person (or company) responsible for fulfilling the obligations outlined in a contract. They must purchase a bond to guarantee the quality of their work performance. The principal is often a business owner.
2. Obligee
The obligee is the party that needs a guarantee (contract) that the principal will fulfill their obligation. They will require the principal to purchase the bond. The bond acts as a safeguard for the obligee in case the principal fails to fulfill the contract for any reason. The obligee is often a government agency.
3. Surety
The surety (or guarantor) issues the bond and guarantees that the principal will fulfill their obligation. The surety assumes the responsibility of paying the debt owed if the obligee fails to meet the contract. They’re like the middleman – working with both the principal and the obligee. Zip Bonds is a surety bond company.
Putting it all together…
Surety bonds tie all three of these parties together through a legally binding contract. The bond assures the obligee that the principal will come through for them and abide by specific laws. If the principal fails to meet their obligation, the surety will step in to cover damages or losses the obligee experiences – more on that in the next section.
How do surety bonds work?
Surety bonds help protect individuals and government entities from malpractice and fraud. If the principal fails to fulfill their contractual obligation, the surety will be required to pay the obligee a specific amount of money. The surety bond acts as a form of credit. The principal is responsible for paying the surety back for any claims made on the bond.
When the principal fails to fulfill their promise, the obligee can make a claim on the surety bond to recover their losses. The surety will examine the claim to see if it’s valid. If it is, the surety company will pay the obligee, and the principal will then owe the surety company for that amount.
Here’s an example…
A governmental agency called CoolGov (obligee) hires a construction company called Happy Contractors (principal) to build a rooftop patio for employee happy hours. Happy Contractors is required to obtain a construction performance bond to ensure they fulfill the contract terms. Happy Contractors will contact a surety company called Zip Bonds to purchase the bond.
The new surety bond protects CoolGov by guaranteeing Happy Contractors’ work performance. If Happy Contractors fails to fulfill their obligation, CoolGov will make a claim on the bond, and Zip Bonds will step in to compensate CoolGov for their losses. Happy Contractors must then pay back Zip Bonds for the claim and any associated costs.
How to Get a Surety Bond
Some insurance companies sell surety bonds. Look for a company that specializes in surety bonds over general insurance providers. The Small Business Administration (SBA) also has a Surety Bond Guarantee Program to guarantee some types of surety bonds.
The principal can obtain a surety bond by paying the surety company a premium. The principal must sign an indemnity (compensation for losses) agreement, committing to reimburse the surety if the obligee files a claim. The principal must pledge their company/personal assets when signing the contract.
Types of Surety Bonds
Here are the most common types of surety bonds.
Contract Bonds
About two-thirds of all surety bonds are written for contractors. The government or project owner will ask a contractor to fulfill a contract, so the contractor will obtain a surety bond to guarantee their performance.
Types of contract surety bonds include bid bonds, payment bonds, performance bonds, and warranty (maintenance) bonds. You’ll be required to obtain a contract bond for any federal projects worth $150,000 or more.
Commercial Bonds
Federal, state, and local governments, legislation, and other entities may require businesses and individuals to obtain commercial bonds to protect public interests. Principals in these types of bonds are often contractors, auto dealers, liquor stores, notaries, and licensed professionals.
Types of commercial bonds include court bonds, license and permit bonds, fiduciary (probate) bonds, public official bonds, and miscellaneous bonds.
Court Bonds
Court bonds help protect individuals or companies during court cases. Plaintiffs, defendants, and estate administrators use these types of surety bonds. The four main types of court bonds are administrator bonds, attachment bonds, guardianship bonds, and cost bonds.
Fidelity
Businesses can buy fidelity bonds to safeguard against employee theft or dishonesty. They can help protect companies, employees (past and present), trustees, partners, and directors. Fidelity bonds include business service bonds, employee dishonesty bonds, and ERISA (Employee Retirement Income Security Act) bonds.
Companies that deal with expensive items or large amounts of cash – like casinos – may need fidelity bonds. Businesses that hire mass numbers of employees or have employees who make home visits may also require them.
When would you need a surety bond?
If you’re a contractor, licensed professional, or company seeking to work for a governmental entity, you may be required to get a surety bond. Check your federal, state, and local regulations to learn about surety bond requirements in your industry.
Get a Surety Insurance Quote
Zip Bonds can help you identify which types of bonds you need to fulfill your obligations. Contact us to learn more.
Request a surety bond quote online.