Surety bonds are a frequent requirement for a number of industries as well as individuals. If you discover that you need a bond, you will want to know how surety bonds work. This guide will examine everything you need to know about surety bonds.
What is a surety bond?
A surety bond is a legally binding agreement that ensures contractual obligations will be met. There are three parties in the agreement:
The principal is the business entity or individual that needs the surety bond. Principals can be a professional that needs a bond to get their professional licenses. Or they can be contractors who want to bid and perform work on construction projects.
The obligee is the entity that requires the surety bond. This is typically a government agency. They enact a bonding requirement in an effort to protect the general public, customers, and themselves in the event that the principal does not perform as they said they would.
The surety is the bonding company responsible for issuing the surety bond. They make a guarantee to the obligee that they will pay out financial damages if the principal violates the terms of the bond leading to a successful claim.
How do surety bond agreements work?
By getting a surety bond, you agree to abide by the terms of the bond. What this means will vary depending on the reason you need the bond. The specific conditions as to why and how you need to get bonded are set by the obligee.
If the bond is required as part of a professional license, your business must operate within all rules and ordinances established by any regulatory authority. If you violate the bond agreement, other parties can make a claim against the bond.
Each surety bond has a stated bond amount. This bond amount refers to the maximum amount of coverage for the bond. This amount is often called the penal sum. When a claim is made against the bond, it cannot exceed the bond’s full amount.
While the surety bond is backed by the surety company, financial responsibility ultimately rests with the principal. The surety will pay any successful claims, however, the principal is required to repay the surety for any damages they cover.
As part of the bonding process, the surety company will make the principal sign an indemnity agreement. This is why surety bonds are often viewed as lines of credit extended from the surety company to the principal.
What is an indemnity agreement?
An indemnity agreement is a legally binding promise that makes you liable for any costs incurred by the surety.
Indemnity agreements may require you to pledge your personal or business assets as reimbursement for the surety company.
Bonds vs insurance
When first getting started with surety bonds, many people assume that they are the same as insurance. While there are a few similarities, the two products are quite different.
Businesses get a variety of insurance policies to protect themselves and third parties that may suffer losses not resulting from the business’ negligence. Surety bonds don’t protect the principal. They are, in a sense, insurance for the obligee as it gives them protection against negative events resulting from the principal’s actions.
How much do surety bonds cost?
The required bond amount for surety bonds varies depending on the bond type. This can range from as low as $1,000 to over $100,000.
As stated, the bond amount represents the maximum amount of coverage the surety company is willing to pay in the event of a successful claim. This does not mean this is the amount that you need to pay to get the bond.
Similar to an insurance policy, you only need to pay a premium. This amount is a small percentage of the potential coverage. Premium rates are determined by the surety based on the likelihood of claims being filed against the bond. They typically range between 1% and 5% of the bond amount, but this can vary wildly based on several factors.
Certain bonds are considered riskier than others and will naturally require a larger premium. For some bonds, the surety company will evaluate your personal qualifications to assess the chances of you receiving a claim, as well as your ability to repay the surety in the event of claims.
Below are some of the key factors surety companies may look at when underwriting the premiums for surety bonds:
- Credit score
- Financial standing
- Industry experience
Some surety bonds are issued for the same cost regardless of the principal’s qualifications.
How can you lower your bond cost?
To start, you can get a lower surety bond premium by improving your financial situation. There are several financial factors that impact how much you pay for a bond.
In most cases, your credit score is the most important. Sureties see negative credit history as an increased risk. With an increased risk, the surety needs a way to guard against the potential losses.
If you have any past collections, judgments or liens, you want to make sure to pay these off before applying for a bond as it can help lower your rate. With strong financials, you’ll get a better rate for your bond.
Another way you can get a lower cost for your surety bond is to demonstrate experience in your industry. Experienced professionals know more about their trade which helps them avoid claims against the bond.
Above all, who you choose as a surety bond provider will impact how much you pay.
Types of surety bonds
Surety bonds are typically divided into four categories: commercial bonds, license and permit bonds, court bonds, and fidelity bonds.
Let’s examine each of the types of surety bonds further:
License and permit bonds
These bonds are required to obtain licenses and permits for various industries. Licenses that require a bond will make it clear in the qualifications and application process. They will let you know the amount of the bond and where you can go to get it.
In most cases, you will need to get the bond before you get the license. For others, you can get initial license approval and then get the bond after.
Here are some of the most common license and permit bonds:
Auto dealer bonds
These bonds let you sell motor vehicles to the general public. The types of vehicle sales that can require a bond include cars, motorcycles, all-terrain vehicles (ATVs), watercrafts and trailers, among others.
The bonds are put in place to ensure that dealers conduct business ethically and in a manner that doesn’t threaten the safety of customers.
Contractor license bonds
These bonds are required by various contracting professions before obtaining a license. Common contractor license bond requirements include general contracting, electrical contracting, plumbing and HVAC contracting.
Contractor license bond requirements vary across states. Some will mandate bonds while others won’t. Additionally, there are cities and local municipalities that often have their own surety bond requirements for contractors.
Freight broker bonds
These bonds allow a company to operate as a freight broker in the United States. They are required by the Federal Motor Carrier Safety Administration (FMCSA). By getting the bond, you agree to abide by their regulations.
Insurance broker bonds
These bonds are often required before you can get a license to operate as an insurance broker. States put insurance broker bonds in place to protect consumers from fraud, misrepresentation, and other harmful acts.
Collection agency bonds
Some states require collection agencies to get a surety bond before starting their business. The bonds can help protect the public from unlawful debt collection practices.
Money transmitter license bonds
Some states require money transmitter license bonds for individuals and businesses that transfer funds to other parties.
The next type of surety bond is commercial bonds. These bonds share a similar purpose as license and permit bonds. They are required by various commercial entities before one can conduct their business.
Below are some of the most common types of commercial surety bonds:
Alcohol and liquor bonds
These bonds allow for the manufacturing and distribution of alcohol and liquor. They are put in place to ensure that the principal complies with all regulations and pays any state sales tax.
Sales tax bonds
Businesses often need to get a sales tax bond to ensure that they pay all tax liability to the state. If a business was to not pay the appropriate amount of taxes, the Department of Revenue or Secretary of State would use the bond to cover any outstanding amounts.
Lottery and raffle bonds
Most states require an individual or business to post a lottery bond to be eligible to sell lottery tickets or operate lottery equipment. The bond provides protection to consumers by ensuring that the principal complies with all regulations.
Fuel tax bonds
Fuel tax bonds are required to be eligible to sell motor fuel. They are also required for distributors, suppliers, and importers of other various fuel types. The bond provides a guarantee that the fuel seller will remit their full tax liability to the IRS on time.
Utility deposit bonds
Utility companies may mandate a security deposit from new customers. Other times they may offer the option to post a surety bond instead. Some customers decide to post the bond as it requires a smaller upfront investment.
The bonds are put in place as a way to help protect utility companies from customers who fail to pay for their utility usage.
Next, we have court bonds. These surety bonds are required for a variety of different legal proceedings. Some of the situations in which you may need to get a court bond include:
- To appeal a court decision
- To become a legal guardian of a minor or an incapacitated/incompetent individual
- To operate as a fiduciary or executor of an estate
There are two primary types of court bonds: judicial bonds and probate bonds.
Judicial bonds are required in certain proceedings to limit financial losses that could result from the court ruling.
Probate Bonds (also called fiduciary bonds) are required when a fiduciary is appointed to manage an estate. These bonds ensure that the fiduciary fulfills their court-appointed duties and that the interests of the beneficiary are safeguarded.
Below are the different types of judicial bonds:
Appeal bonds are often needed if an individual appeals a lower court’s ruling. The court requires these bonds to ensure the original judgment is paid if the appeal is denied and that the individual pays any interest and costs.
These bonds are required if a plaintiff wants to include the defendant’s property as an attachment for a pending claim. The bond guarantees that the plaintiff will pay damages for wrongfully holding the property if the judgment favors the defendant.
These bonds are required when a plaintiff claims ownership of the defendant’s property and sues to get it back. The bond guarantees that the plaintiff will return the property and pay damages for wrongfully holding the property if the judgment favors the defendant.
Fidelity bonds function a little differently than the other surety bonds in this guide. In essence, they help protect businesses and their clients from financial losses resulting from the illegal and dishonest acts of the business’ employees.
They differ from traditional surety bonds in that they follow a two-party agreement rather than a three-party agreement. They are similar to insurance policies in this regard but still have the other underlying characteristics of a surety bond.
Janitorial and business services bonds
Many cleaning services will get a janitorial bond to provide reassurance to their potential clients. If an employee were to steal from a client, the surety company would pay for the losses (up to the bond amount) and the business would be responsible for reimbursing the surety company.
ERISA bonds are a type of fidelity bond designed to protect individuals who participate in employee benefit plans. The bonds ensure that the fiduciaries or individuals in charge of overseeing the employee benefit plans manage the assets honestly and responsibly.
Surety bond guide frequently asked questions
Most surety bonds aren’t valid for an indefinite period of time. They will expire at a set date. The duration of a surety bond is determined by the type of bond. Many bonding terms coincide with the term of the license that mandated the bond.
Surety bonds normally remain valid until they expire. If the surety company chooses to cancel the bond, they will issue a notice of cancellation.
There are a variety of reasons why they would choose to cancel the bond. They will likely have a cancellation clause that specifies under what conditions a surety may cancel the bond.
Get your surety bond with EZ Surety Bonds
To get your surety bond, search our site for the bond you need and fill out the form to get the process started. We offer quick and efficient online bonding and can even issue many bonds instantly.