A surety bond is a contract between three parties: the principal, the surety, and the obligee. The principal is usually a contractor, the obligee is usually a third-party ensuring completion of the work, and the surety is the insurance agency guaranteeing the bond should it need paid out.
How Does a Surety Bond Work?
Basically what happens in the case of a surety bond, the insurance company is the ‘surety’ backing the bond and supplying a line of credit in case the principal (contractor) fails to complete the project they set out to perform. The obligee, typically a government agency regulating an industry to limit the risk of financial loss, is the entity requiring the bond. Keep in mind, contract surety bonds are not the same as license bonds, which may be required as part of a license to perform certain kinds of work.
How Much does a Surety Bond Cost?
Pricing is usually determined based off a personal credit score or one tied to an enterprise and a percentage of the total bond amount. The percentage required ranges from 1% to 15% depending on the calculated risk of the work being performed. For example, if a $10,000 surety bond is required, a low risk 1% rate would only cost $100. Contract surety bonds are generally considered more risky and quoted around 10%, so that principal amount would be $1,000 in this example.
Examples of Contract Surety Bonds
Bid bonds assures whoever the project owner is that the contractor submitting the bid has the capabilities to complete said project to the correct specifications outlined in the original bid.
Performance bonds are more contractual oriented and protects the owner in case specific agreements between the contractor and said owner. Generally, performance bonds guarantee 100% of the contract’s total costs and owners can claim that entire amount if they feel the right to do so.
When subcontractors are involved with a project, payment bonds are used to guarantee that the general contractor pays out all necessary funds. Payment bonds therefore really protect the subcontractors and laborers of a project and are required by many federal construction projects. The amount of a payment bond reflects the estimated labor costs originally outlined in the contract.
Any time there is defective workmanship or faulty materials used during a construction project, a maintenance bond protects the owner against financial loss. They are only required at the discretion of the owner and there is a set time where the owner can file a claim after project completion, usually 1-2 years.
Who Typically Uses Contract Surety Bonds?
Contract surety bonds are commonly used by the following people and organizations:
- Subcontractors of the federal government typically on projects over $100,0000
- Construction management agencies overseeing multiple projects at once
- Trade contractors such as electricians, carpenters, plumbers, etc.
- Individual contractors working on one project at a time
Who Typically Requires Surety Bonds?
There are two main reasons why surety bonds are required: at the discretion of an owner in the private sector, or a statutory requirement in the public sector. Local and state governments will require them as payment protection for suppliers and laborers on the project, especially when prevailing wages or some other type of qualified workforce is being called upon to do the contracted work. The federal government’s interests primarily lie with protecting the taxpayer dollars and assuring the lowest bidder is qualified and capable to finish the project to specification.
Commercial bonds represent the broad range of bond types that do not fit into contract surety bond categories. These bonds are divided into four subtypes: public official bonds, court bonds, license and permit bonds, and miscellaneous bonds.
Public Official Bonds
Before assuming public office, any official that is elected, appointed, or hired to fulfill governmental duties, a public official bond is required. Public official bonds essentially guarantee these governmental duties are fulfilled which includes properly accounting for any and all public funds being handled by that particular office. If any obligation fails, the surety must pay for the damages and the official is liable to repay the surety for the loss and/or any amount the bond did not cover. There are also federal official bonds which are required for any federal official, and also anyone operating a post office from within another business must acquire a federal post office bond.
Also known as judicial surety bonds, these bonds are used to protect a company (or person) against losses in the court of law. They can also be required by law too. The most common examples of when court bonds are required is when appealing a court decision, becoming a legal guardian of a minor, or settling an estate while acting as the fiduciary. These bonds are broken down further into two main categories: judicial bonds and fiduciary/probate bonds. A judicial bond promises a lump sum of money required in a court case and arise out of litigation when parties are seeking court remedies. Fiduciary bonds are filled in probate courts and guarantee that persons whom such courts have entrusted with the care of others’ property will perform their specified duties faithfully and ethically.
License & Permit Bonds
License and Permit bonds are required by certain municipal, state, and federal governments are prerequisites to receiving a license or permit to engage in certain business activities. Some specific examples include contractor’s license bonds, tax bonds, reclamation and environment protection bonds, broker’s bonds, ERISA (Employee Retirement Income Security Act) bonds, motor vehicle dealer bonds, money transmitter bonds, and health spa bonds.
For any bond that have a unique purpose and do not fall easily into the above classifications are referred to as miscellaneous surety bonds. Most, though not all, serve the private sector to support some type of business transactions. Some examples of miscellaneous bonds include: ocean transportation intermediary bond, self-insured workers compensation guaranty bonds, credit enhancement financial guaranty bonds, and union bonds.