What is Surety Bonding and When Do You Need It?
Are you a general contractor, subcontractor, or someone who works regularly in construction? Have you heard of surety bonding or surety construction but don’t know what either of those things is? Well, if you work in this industry, your business efforts may require you to know the ins-and-outs of surety bonding.
Don’t know why surety bonding is important or why and when you would need it to do business? In this article, we’ll cover everything you need to know about surety bonding, so you can handle this kind of bond should you ever need one.
What Is Surety Bonding?
Surety bonding is a type of insurance policy. It’s a legal agreement that involves three unique parties:
The Principal
The first party is the principal, which is the person who applies for and buys the bond. They’re often a business who needs a bond to obtain a government license or bid on a construction contract. They need this bond to show the obligee that they’ll be protected if the work is unfinished or any unethical business deals happen.
The Obligee
The obligee is the party that requires the surety bond. They need this bond to cover any costs or damages that the principal may incur, such as if they fail to complete the job or don’t pay all their labor bills. This party is often a government agency, but it can also be an individual, group, or company.
The Surety
The final party in surety bonding is the surety itself, which is the insurance company that supports the surety bond. Their job is to make sure that the principal will complete all tasks outlined in the agreement between the three parties. They back up the bond entirely, enforce the contract, and cover any costs that may be incurred, which the principal is then required to pay back.
How Does the Surety Bonding Process Work?
The purpose of a surety bond is to protect private and public interests against any bad actions on behalf of the principal. If this person fails to complete their duties or performs any bad behavior, the obligee can file a claim. The surety pays for all the damages on behalf of the principal, and after that, the principal repays the surety.
4 Types of Surety Bonds
There are many types of bonds available, but 4 surety bonds are more commonly used than others. Here are the 4 most common types of surety bonds you’ll run into:
Contract Surety Bond
A contract surety bond promises that a principal or contractor will follow all the obligations specified in their construction contract. The obligee is a project owner, and the surety bonding guarantees that the contractor will fulfill their duties and also pay for any necessary materials or labor fees.
Commercial Surety Bond
Government agencies usually require this bond to protect the public interest. It’s most commonly required for new businesses that are looking to open a business in a specific sector like the liquor industry. The obligee in these cases is always the public.
Fidelity Surety Bond
This bond protects a company from employee malpractice or the loss of things like a customer’s money, personal supplies, or equipment. It also protects against any fraudulent behavior at the hands of employees.
Court Surety Bond
This legal bond is generally required by an attorney before a court case occurs. It essentially guarantees any payment related to legal fees, but it can also cover fees related to previous court decisions. This bond is also commonly used to protect an estate against any kind of malpractice on behalf of the estate manager.
How to Get a Surety Bond
The first step in the surety bonding process is figuring out which type of surety bond you actually need. There are thousands of types of bonds in the United States, and if you purchase the wrong one, your bond will most likely be rejected by the obligee. If your bond is not for a specific contract, it will most likely fall under one of the three following categories:
- License bond/miscellaneous bond
- Court bond
- Fidelity bond
Once you know which bond you need, you’ll have to apply for it. If your application is approved, your bond agent will tell you what your bond premium will be and give you the agreement you’ll sign with the bond company. You’ll then pay a premium and receive the original bond, as well as the power of attorney from the surety.
How Much Does a Surety Bond Cost?
The cost of a surety bond depends on a variety of factors, like applicant’s credit rating, the type of bond involved, and the kinds of risks the obligee is willing to take. Applicants with good personal credit will generally pay an annual premium that’s between 1-3% of the total bond amount. If you have bad credit or are applying for a bond in a higher-risk market, you’ll have to pay an annual premium that’s between 5-15%.
When Do You Need a Surety Bond?
Generally, the obligee requires the principal to take out a surety bond to lessen any risks. But if you’re a contractor looking to get your license from the state government, you most likely will need to get a surety bond as part of your application. There are also many industries, such as the liquor industry, that require you to purchase this kind of bond in order to obtain a license.
If you’re a contractor involved in construction, you may also need to get s surety bond before you can agree to a construction contract. And even though it’s not always required many people take one out to make the obligee feel less at risk or to win a contract from a skeptical client.
Final Thoughts on Surety Bonding
If you’re involved in construction efforts or looking to get involved in a new industry, you need to know how surety bonds work to be successful. By understanding the what, how, and when of these bonds you can conduct business in a better way.
Are you a contractor looking for your next construction project? Have more questions about surety bonds? Let us know in the comments!
