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  What is a Surety Bond? (Frequenty Asked Questions)

What is a Surety Bond?
A bond is a three-way agreement between the Surety, the Principal (who is the contractor or applicant) and the Obligee. Obligee is a technical word for a beneficiary, who might be the project owner, government agency, etc. The Surety is the party standing behind the performance of the Principal. The Surety has evaluated the Principal's ability and willingness to perform and is providing their stamp of approval with a bond. If the Principal is unable to satisfy the terms of their agreement, the Surety assumes the responsibility and reimburses the Obligee.

Is a Bond anything like insurance?
Bonds are considered a specialty form of insurance, and the Surety is almost always an insurance company. Bonds are very different than insurance, however because the beneficiary is a third party. As long as the Principal does what is promised, the Surety will not be called upon to perform or pay. The Principal is the primary responsible party under the bond, and must agree to reimburse the Surety for any claims or expenses they incurred because the Principal has not lived up to their agreement.

Who benefits from a Bond?
The Obligee is the main beneficiary under the bond, but the Principal benefits too. If the Principal cannot or will not perform, the Surety steps in and makes good on the Principal's obligation. The Obligee also has an obligation under the bond however. If the Obligee fails to fulfill their responsibilities under the contract or agreement, neither the Principal or Surety has any liability.

How can Small, Minority and Women Owned Businesses benefit from Surety Bonds?
Bonds provide small contractors with numerous benefits. The surety bond provides protection against contractor default. The surety company helps the contractor avoid costly delays and contract disputes, by intervening before it's too late. When a project is bonded, there's also an added layer of payment protection for workers and suppliers of the contractor. Surety bonds help level the playing field, and allow a small contractor to compete in the free market, leading to lucrative contracting opportunities.

What types of Bonds are there?
Bonds can be required either by law or contract. Bonds can be broken into the following broad categories: Contract, Commercial, and Fidelity.

Contract Bonds can be required by statute or by private agreement. Some examples would include:

Bid Bonds guarantee the bidder's promise to enter into a contract in the event their bid is accepted.

Performance Bonds can be required for construction, supply or service contracts, and guarantee the principal will perform in accordance with the terms and conditions of the contract, purchase order, or service agreement.

Payment Bonds are usually paired with Performance Bonds, and are required to guarantee that all suppliers and laborers on a bonded project will be paid.

 

Commercial Bonds are generally required by statute, and guarantee some aspect of the Principal's operation. Some examples would include:

License and/or Permit Bonds are required by government entities and basically protect against consumer fraud or assure public safety.

Union Welfare Bonds guarantee the contractor will stay current with their example of a court bond commonly required by small contractors is to release a mechanics lien.

Tax Bonds are required by government entities and guarantee that the principal will pay their taxes in accordance with the governing law.

Court Bonds can be required of either party in a lawsuit, and guarantee the principal will pay any settlement or damages the court awards against them. An example of a court bond commonly required by small contractors is to release a mechanics lien.

Miscellaneous Bonds generally guarantee the financial performance of many forms of agreements.

 

Fidelity Bonds protect the employer from dishonest acts committed by their employees. Some examples include:

Janitorial Services Bonds provide protection for customers of cleaning businesses. Employees are easy targets for blame when something is missing since they have access to customers' assets, equipment, supplies and personal belongings.

Employee Dishonesty Bonds guarantee that the bonded employee(s) will handle their employer's money and property with trustworthiness. Small companies can be especially hard hit because they can't afford extensive safeguards and do not have the financial capacity to absorb the losses.

Pension Trust (ERISA) Bonds are required by The Pension Reform Act of 1974, which states that the fiduciaries of a pension or profit sharing fund are required to post a bond for 10% of the amount of funds handled. Pension plans and profit sharing programs are managed by appointed individuals known as plan fiduciaries.

How is a Surety Bond underwritten?
Surety Companies will evaluate financial information, detailed credit history of the business and it's principal owners, along with management's experience. Based on the Surety Company's expert decision making ability, they will not only be able to assess a Principal's ability to pay or perform an agreement, but the Surety will be able to determine the Principal's willingness to fulfill their promise.

What is indemnity?
The indemnity agreement is the legal document that fully discloses the Principal's obligations in a surety relationship, and allows the Surety the right to recover any losses paid out on behalf of a Principal. The Principal is the primary responsible party under the bond, and must agree to reimburse the Surety for any claims or expenses they incurred because the Principal has not lived up to their agreement.  

What happens if a claim is filed against my Bond?

The Surety's claim department will conduct an investigation as quickly as possible to avoid any further damages and mitigate their exposure. It is important to note as the Principal under a bond, that a pending claim does not necessarily mean there will be a financial loss incurred since the dispute may not even be legitimate. If the Surety does determine through their examination that the claim is valid, the Principal will be reminded of their obligations under the indemnity agreement and given the opportunity to satisfy the claim first. If the Principal fails to respond, the Surety will arrange settlement with the Obligee, and implement collection proceedings against the Principal.

How much do Bonds cost?
Generally speaking, contract and commercial bonds can cost between .5% and 3% of the contract price or bond amount, depending on the surety's assessment of the risk involved. There is also a $50 service charge for each bid bond, regardless of the contract price. The cost of fidelity bonds usually depends on the number of employees covered.union dues, wage and fringe benefit payments.