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Understanding the 4 Main Types of Surety Bonds

Understanding the 4 Main Types of Surety Bonds

There are over 50,000 surety bond types in the nation and no official or legal way to properly divide them into categories. Surety bonds can be extremely tricky to understand, especially from the perspective of a small business owner with little legal experience. The purpose of this article is to break down the many kinds of surety bonds into 4 distinct categories and explain why people and businesses use surety bonds. Let’s break down a few key terms you’ll need to know before getting started. 

Surety Bond

To put it simply, a surety bond is a guarantee. In contrast to other “guarantees’ like insurance, a surety bond is a contractual agreement between 3 parties rather than the usual two parties. The principal, the obligee, and the surety. 

 

The Principal

The principal is the party that takes out the surety bond required by the obligee. If there are any breaches or unethical business practices on behalf of the principal during the duration of a contract, the surety bond will protect the obligee. The most common principal in a surety bond is usually a business that is seeking to obtain a license from the government or bid on a contract.

The Obligee

The Obligee is the party that requires the surety bond as protection. Obligees are usually government agencies but they can also be individuals or larger companies. They use surety bonds to cover financial damages in the case of a claim. For example, let’s say a private contractor fails to pay a hired subcontractor or pay for labor after a job is completed. Then the obligee would be able to file a claim using a contract surety bond. 

The Surety

The Surety is the party that provides the assurance or “surety” that financial aid will be provided to the obligee in the case that the principal does not fulfill their part of a contractual agreement. A surety bond works like a compound insurance policy and line of credit. After a principal takes out a surety bond, they pay an annual bond premium which is typically between 1% – 15% of the total bonded amount until the contractual agreement is complete. In the event that the contract is broken the surety will pay out the necessary claim to the obligee and pursue the principal for the funds specified in the contract when the bond was first created including legal fees. 

Now that we understand the three different parties involved in surety bonds, we’ll break down the 4 main types of surety bonds into four different categories: contract bonds, commercial bonds, fidelity bonds, and court surety bonds

Contract Bonds

A contract surety bond ensures that a contractor will follow all outlined specifications described in a construction contract. The obligee party of a contract surety bond is typically a project owner and the surety bond ensures that the commercial contractor will complete the work agreed upon and will also pay all subcontractors for materials and supplies.

Contract surety bonds cost the principle between 1%- 15% of the bonded amount. These bonds are unique because they are dependant on the business owner’s personal credit score. Scores above 700 have bond premiums between 1% – 3% while scores below 700 have premiums between 4% – 15%. A business’s past performance is also taken into account when these premiums are calculated. These bonds are paid annually and can have terms between 1- 4 years to be continued or canceled. 

Commercial Bonds

A commercial surety bond is a bond required by government agencies to protect public interests. The government typically requires a commercial surety bond for licensed professionals. For example, contractors are required to use commercial bonds to ensure to their costumers that they will operate with a license and adhere to all building codes, regulations, and conduct. Since anyone who is part of the public can file a claim against the bonded party, for damages, the public is the obligee.

Commercial bonds have a term of one year that the principal is required to renew as part of its license. There are cases where commercial surety bonds have terms that last up to two years before the principal is required to renew it. The size of the amount bonded can vary depending on the following factors: number of physical locations or projects, the total number of employees, annual sales transactions, and the specific license being bonded. 

Fidelity Bonds

A fidelity bond protects a company against the violation of an employee who handles cash and other valuable assets. The bond protects a company against employee theft or dishonesty and is also commonly known as a “blanket bond” because the bond covers the whole company and all of its customers. Fidelity Bonds are often used to protect the money, equipment, or personal supplies of the obligee.

These kinds of bonds are most like insurance because companies are required to take out a policy as low as $10,000 and pay as little as a 1% premium, $100 a year in this case. Annual premiums can reach as high as 15%. It is not uncommon for businesses to take out a fidelity bond that can reach up to $5 million. 

These kinds of bonds can also protect a company from financial loss due to the fraudulent activity of an employee. These kinds are not required but clearly provide a lot of protection. 

Fiduciary & Court Safety Bonds

Before a court procedure, an attorney can require a court bond to ensure protection in the case of a loss. These court bonds typically ensure the payment of costs correlating with lawyer fees or appealing a previous court’s decision. Other court bonds protect an estate against the negligence of the estate’s administrator. 

Court Safety Bonds costs are calculated similarly to the costs of contract bonds. Similar to the other bond types, court surety bonds charge a premium of 1% – 15% based on a person’s credit score. Personal credit scores above 700 receive a rate of 1% – 3% while scored below 700 have rates between 4% – 15%. 

Understanding the 4 Main Types of Surety Bonds

In simple terms, a surety bond is a guarantee that you’ll be covered and receive what you’ve paid for. For inquiries about surety bonds, and surety bond requirements, call The Surety Place today.

November 7th, 2019
SurePlace