Surety bonds are a necessary component of many people’s business operations. Whether you’re starting a new business, finishing a project, or obtaining financing, surety bonds are often required. For over 40 years, our mission has been to simplify the intricacies of the surety bond business. This crash course distills down how surety bonds work so you can get bonded fast and back to running your company.
A Surety Bond Overview
What is a surety bond, and why do you need one? A surety bond is a credit extension to a 2-party agreement provided by a non-affiliated third party. We know…we promised simple…stick with us here and read on.
What do Surety Bonds Do? The Basic Principle.
Think of it as a way to transfer risk connected to a legally binding contract obligation to perform between two parties. How? By inviting in a 3rd party to assume the risk if things go wrong. For a price, of course.
Surety Bond Example – A Simple Analogy.
Let’s take a look at a mortgage example. A bank lends money to a home buyer based on their financial stability and ability to make mortgage payments. A customer may not have the financial status or credit history needed by a lender in order to receive a loan. However, if the buyer knows someone who does, they can be added to the loan as a cosigner. The cosigner benefits the bank because it transfers the risk of the buyer’s inability to pay to the cosigner. The cosigner then steps in to take over the obligation of payments to the bank. The bank has now reduced its risk.
Surety Bond Definition – The Surety Bond Contract
As you can see, a two-party contract now has three parties involved. In a surety agreement, these three parties are better known as the Obligee, the Principal, and the Surety.
The Obligee is typically a government entity, company or business owner purchasing a professional service, and needing to guarantee performance of that service obligation being completed correctly. More often than not, these services relate to construction projects and involve government contracts in an effort to mitigate risk of contractor defaults. These are referred to as contract surety bonds.
However, many commercial surety bonds are available for a variety of industries, including manufacturing bonds, judicial bonds, license and permit bonds, energy bonds, and finance bonds.
For both types of bonds, the Obligee enters a legally enforceable contract that defines the provider’s obligations. The agreement binds and sets expectations for both parties.
The surety bond protects both parties by assuring that these responsibilities are met. The Obligee requires it to protect them financially if the provider fails. They are the ultimate beneficiaries of the surety bond protection.
The Principal is the other party or entity providing the professional service or product for a specified contract price. The surety bond protects the Obligee if the Principal fails and cannot carry out their responsibilities as per their agreement.
The Surety company is the 3rd party that issues the surety bond, also known as a performance guarantee, that guarantees the Principal performs according to their contractual obligations up to a specified bond amount.
The transfer of risk flows from Obligee to the Surety company, where the Surety company steps if the Principal fails. The Obligee is protected, and the Surety company then seeks recourse against the Principal.
That is how surety bonds work! Simple, right? However, there is a non-participating fourth party that manages the bonding procedure for the three parties to the surety bond.
The Surety Bond Agent
To obtain a bond, you’ll need the assistance of a professional surety agent or surety broker, like us. Our duty as surety bond producers extends to assisting the surety company in the underwriting process and facilitating your application to verify that surety bond conditions are met to so you get bonded.
Just as you need a licensed insurance agent to obtain an insurance policy, you need a licensed surety agent when surety bonds are required.
The Surety Company
A surety company is a business that provides contract surety bonds and commercial surety bonds to businesses and professionals. The surety company’s bonds guarantee their underlying contract obligations thereby promising to pay losses up to the bond amount, or surety bond penalty if the applicant fails to fulfill their end of the bargain.
There are many surety bond companies to choose from, but not all are created equal. When looking for a surety bond company, it is essential to consider factors such as its financial stability, customer service, and bonding capacity.
Some of the best surety bond companies include Chubb, Everest, Hartford, Travelers, and Zurich. These are tier 1 surety carriers, but there are many other A+ rated carriers, the majority of who SimplisSurety is partnered with.
Surety Bonds Made Simple
How do Surety Bonds Benefit you?
A surety bond serves as credible proof of the experience, financial stability, and capability that your business will fulfill the obligations you’re being paid to perform. Being bonded tells customers you’ve secured a specific business license and or have been through the process of having qualifications verified and backed by a reputable institution willing to guarantee.
In addition to satisfying the surety bond requirements of the Obligee, it provides you with additional credit as a reputable firm. For principals, bonds can be used more cost-effectively to satisfy performance obligations where a bank guarantee or deposited cash may be required. Why? In many cases, fulfilling the performance obligation requires you to pay some money in a single lump-sum payment or provide a letter of credit to custodians or trustees. These are often more expensive and need more cash than the bond alternative.
Why do we need Surety Bonds?
The principles of surety have evolved over centuries, but we’ll keep the history lesson brief. The first instance of a surety bond was in the Hammurabi Code of Laws, dating back to 1790 BC. First established as a form of individual suretyship, still evidenced today in various court bonds, more modern surety principles stem from Roman jurisprudence.
Surety principles of the current day emanate from the establishment of corporate suretyship out of the U.K. and U.S. in the 19the century. At the time, some private contractors working on publicly funded construction projects had become insolvent. These contractor defaults left construction projects unfinished where taxpayers had to carry the additional cost of supporting them to completion. Subsequently, Congress instilled corporate surety as an option through the Heard Act of 1894 followed by the more current Miller Act of 1935, which federally mandates surety bond requirements on all public works projects.
Since that time, surety bonds have been increasingly used to protect customers in commercial transactions beyond the construction industry.
U.S. States have enacted Little Miller Acts mandating local performance guarantee requirements. These federal and state laws have proven an effective risk transfer mechanism removing the burden from taxpayers and consumers.
Globally, surety bonds are lesser utilized, leaving citizens exposed, particularly on public works projects. A modern-day example is that of Carillion in the U.K., which went belly up and cost taxpayers billions.
Events like these have opened other countries’ eyes to practical uses of surety bonds to safeguard the public, and more so, the value of the surety process.
When do you need a surety bond?
Surety bond requirements are often necessary for licensed contractors working on government-funded projects. These are often mandated and prescribed by their accompanying government contracts containing bond forms indicating what bonds are required.
Even without the mandatory bond, surety bonds protect project owners from principals that do not perform their obligations. For instance, a high-rise developer would find it in their best interest to require their contractor to be bonded as another form of risk mitigation.
Sometimes lenders will require a project owner to mandate their contractors or vendors provide surety bonds as a condition to secure financing.
What does a Surety Bond Protect?
Surety bonds are written as protections for third parties, which include suppliers, vendors. project owners that are often government agencies. Upon alleged negligence, the Obligee could be entitled to recover financial losses against the bond for any damages if a claim is made against the Principal. The Surety then investigates the claim, and upon its validation, compensates the Obligee and holds the Principal liable to seek recourse against.
What does a Surety Bond cover?
In acquiring a surety bond, the Principal applicant must comply with specific underlying obligations of a contract. If the Principal defaults, the Obligee has rights to make a claim on the bond. The bond itself covers the Principal’s compliance to completing the underlying obligation.
Who buys Surety Bonds?
Surety bonds are bought by businesses of all types, primarily when contracting with a government agency or government-funded project.
Many bonds are often purchased to meet the employment licensing requirements of a governmental institution. Each obligation has a specified bond form describing the bond conditions and often referencing states laws and the law governing the bond to which the principal must adhere.
How long does it take to get a Surety Bond?
With Simpli Surety, applications can get approval and receive the bond the same day if qualified. An applicant must provide basic information including company info, personal information, names, addresses, and social security numbers. Simpli Surety’s underwriting is automated and offers quick approval and pricing. Apply online with us for upfront pricing and same-day service.
How much do Surety Bonds cost?
Costs are determined by factors such as the type of bond, the coverage period, risks to the Principal’s credit scores and previous claims record, financial resources, and other factors. Based upon this information, premiums may differ but generally fall within 1-6% of the total bond amount, also called the bond penalty.
Types of Surety Bonds
Surety bonds fall into two distinct categories:
- Contract – basically anything related to construction
- Commercial – everything else not related to construction.
Commercial Surety Bond
Commercial Surety Bonds are required by a government, legislation, or governmental authority. The surety bond ensures that all the relevant conditions and terms related to the underlying obligation of a contract are followed. If they are not, the surety binds itself to pay for any damages suffered by the Obligee due to noncompliance with rules or regulations pertaining to state laws, a governing body or authority on the part of the applicant.
The types of common surety bonds are:
- License and Permit Bonds
- Court Bonds
- Fidelity Bonds
- Performance Bonds
- Bid Bonds
- Commercial Bonds
- Payment Bond
Contract Surety Bonds
A contract surety bond guarantees that a construction contractor will complete, adhere to their construction project bid price, complete a project per the construction contract specifications and pay their vendors and subcontracts as agreed upon. These are categorized as bid bonds, performance bonds and payment bonds respectively.
All Surety Bonds Guarantee Performance
While there are nuances to every bond, the critical takeaway is that each is tied to an underlying contract obligation. Or, an act that is agreed upon between parties and must be completed.
Most contract bonds are completion oriented for a specific project. For example, a contractor completing the construction of an overpass for the state government must adhere to budgets, timelines and scope.
Surety bonds can be less about completing projects and more about protecting clients and other interested parties from unfortunate situations in commercial situations. For example, a motor vehicle dealer bond assures customers that the dealer they work with is well versed and compliant in all laws and codes. Or it may be that a customer needs to be protected from a mortgage broker practicing unethical and illegal actions. The bond ensures the mortgage broker will complete their service per the guidelines set forth within the industry.
If the Principal and Obligee, abide by the contract terms, thereby allowing the Principal to complete their obligation – all is good!
Only when the Principal does not abide by or complete their obligation, is the surety then called upon to step in. This formally occurs when the Obligee makes a claim on the bond. However, in certain instances, the surety and surety agent may get involved much sooner to remedy before a claim needs to be made.
How does a Surety Bond work?
Surety bonds primarily function under the principle of indemnity. What’s this mean? The surety will take on the financial burden caused by the Principal’s default and, in doing so, compensate the Obligee for losses incurred as a result.
This occurs when the Obligee files a claim against the bond, and the claims process kicks off. If the claim is deemed valid as per the provisions outlined in the contract language of the bond and in accordance with the underlying contract, the surety will pay out to the Obligee.
After the Obligee is made whole, the surety is left suffering the financial loss! That’s not a sustainable business model, of course, and this is where indemnity kicks in. The bond’s accompanying indemnity agreement allows the surety to seek recourse against the Principal, their company and personal assets within the courts. This is how the bonding company recoups its loss. It can play out differently each time, therefore the justification of the premium charges in accepting the transfer of risk.
Does your company need a surety bond?
The answer is derived from the language of the underlying contract, requests for proposals (RFP), quotes (RFQ), conditions to secure financing, or state applications to conduct business. At that point, you’ll want to instantly apply for a surety bond here.
Public Government Agencies vs. Private Project Owner
Public entities often require bonds as part of a legal statute, federal and state. The rules surrounding these bonds vary from state to state. If conducting business across various states, it’s crucial to understand the surety bonding requirements where work is being done.
Suppose you’re a construction company or subcontractor working on government-sponsored projects. In that case, you’ll likely encounter a bond mandate requiring a bid bond, performance bond, payment bond, or combination of these contract bonds. In fact, for specific federal projects, you may not be able to submit bids until you secure surety bonds.
Commercial bonds are less prevalent on construction projects but are often required as a part of conducting business and vary state to state.
For example, a New York surety bond is necessary if you work as an insurance company adjuster, a private investigator, or a mortgage loan originator. If you own a nail salon in New York, surety bonds are also required for that business. Meanwhile, Missouri might not require any specific bond to those industries.
In New York surety bonds are required if you sell or distribute alcohol, operate a for-hire vehicle, or function as a professional fundraiser. Conversely, if you own a business that requires your employees to work in other peoples’ homes, you might not need a surety bond. Although, that doesn’t mean you shouldn’t have one. A business service bond protects your clients in case of theft or damage while your employees are in their homes.
New Jersey surety bond requirements extend to contractors in certain specialties needing to get bonded, such as electricians and plumbers.
Private entities, such as real estate developers, are not bound by legal mandates. They may encounter surety bond requirements placed upon them by lenders, ensuring that the developer will complete the building they are lending on. In turn, developers may require subcontractor bonding to be sure they will complete their designated portion of the project. In these cases, surety bonds still play a critical role in private projects, but they are not legal requirements.
You may need a surety bond if you are:
- A contractor or subcontract performing work for a publicly funded project, for instance, the Department of Transportation or a Local Municipality.
- Securing financing from a bank or small business administration where a condition of the loan agreement is a performance bond to ensure completion of a project.
- Firm buying materials from a supplier that requires advance payments.
- One of the many occupations or businesses requiring licensing.
If your state or occupation doesn’t otherwise mandate a bond, you likely don’t need one.
Conversely, being bonded even when it is not necessary might give your customers the confidence they need to choose to do business with you in the first place. A bond’s assurance brings the customer comfort knowing your company has been vetted, and all parties are protected.
What are some common types of surety bonds?
Perhaps you know which bond you need already. In that case, our instant issue surety bond is where you’ll want to go next.If unsure or curious, read on. Many bonds can help your business, from ensuring payments from clients to putting cash back into your bank account.
The Big 3 Construction Surety Bonds aka Contract Bonds
The majority of surety bonds (approximately 70%) are written for construction projects. Most states require a bond for construction industry activities.
So, what are performance bonds and what are contract bonds? Several terms are sometimes used that are interchangeable with surety bonds. A surety bond may sometimes be referred to as a performance bond or a contract bond.
Let’s dive into the three main types of construction bonds:
Bid bonds are a common requirement in construction and serve as your tickets to the dance. Certain local governments require them to participate in the bidding process, ensuring your bid is legit. Your company will need to hold a bid bond before you can bid for specific construction jobs.
Performance Bonds
Ensures completion of the project to specification, time, and budget as per the defined obligations within a contract.
Payment Bonds
Guarantees that labor, materials, and equipment used in the project will be paid fairly and on time from contract proceeds.
If you’re a contractor or subcontractor, these construction bonds are worth getting familiar. Bonded construction offers excellent protection for both you and your clients. Construction bonds show your customers that you take your work and safety seriously.
Commercial Bonds – Fiduciary, License, Permit & More!
Commercial bonds are generally more transactional. This category is broad so let’s break them down by use. These bonds are less long-term and apply to many service-based businesses.
Janitorial and custodial services may be bonded to protect their clients against theft. A similar bond can be used for businesses with employees who work in clients’ homes. Being bonded tells your clients that your employees are accountable to you, just as you are accountable to your clients.
You will need to hold a surety bond if you operate a business that specializes in collections, notary, tobacco or alcohol sales, running a lottery, appraisals, auctioneering services, driver training, and many others.
A unique surety bond is the athlete agent bond. This bond is required in certain states where athlete agents are responsible for recruitment. These are particularly necessary for those agents who focus on college or university-level athletics. It also assures higher education institutions that you will not offer monetary rewards to the athletes you recruit.
A unique surety bond is the athlete agent bond. This bond is required in certain states where athlete agents are responsible for recruitment. These are particularly necessary for those agents who focus on college or university-level athletics. It also assures higher education institutions that you will not offer monetary rewards to the athletes you recruit.
Another unique, non-construction bond is the California Car Wash bond. This bond is required for anyone who wishes to open a car wash in California. It assures that the car wash owner pays all wages and benefits owed to any employees.
Common Commercial Bonds
| Auto Dealer Bonds | Freight Broker Bonds |
| Mortgage Broker Bond | Maintenance Bond |
| Notary Bonds | Financial Guarantee Bonds |
| Warehouse Bonds | Escrow Bonds |
| Letter of Credit Replacement | Advance Payment Bonds |
Do I need a Surety Bond?
U.S. surety requirements vary by occupation and industry. Many common bond types revolve around licensing requirements, such as auto dealers bonds, contractor license bonds, mortgages bonds, and freight broker bonds. Check your state and industry using our search for bonds you may need.
How to Get a Surety Bond?
Going through the bonding process will help determine the specific requirements depending on your job position or company, state, or county.
How to get a bond of any type requires knowing the exact specifications needed for the kind of work you’re pursuing. Typically this is stated in the respective bond form of application for that work.
Often this will state the qualifications required to perform, including financial, experience, and legal requirements.
In many commercial instances, you only need to know which surety bond you need and the bond amount you need to qualify for according to industry requirements.
Then there are more complex cases such as some performance bonds for construction which require information on the business, principals, financials, and the project contract.
These variables factor into calculating the surety bond cost, which usually ranges from 1-6%, depending on complexity.
How to Find a Surety Bonding Company Near Me
In this day and age, they don’t have to be near you. Then again, finding a reputable bonding company isn’t always as simple as an internet search.
Talk with your financial lender, insurance agent, or financial planner. The Surety & Fidelity Association of America also has tools to help you find a bonding company licensed to provide bonding in your state.
Our secure online portal provides immediate bond application access and, in most cases, instant surety bond issuance so you can focus on your business. We are licensed in every state across the U.S. and have been in the industry for over 40 years.
How do I apply for a Surety Bond?
Different states and cities have diverse requirements for a surety bond. There must be clarity about the guarantee’s requirement.
There you have it, what is a surety bond, answered! Contact us today for an instant bond or learn how we can help you secure the proper surety bond for your company.
Find your instant online surety bond application here.
