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What Is a Surety Bond? Types of Surety Bonds and How They Work

By October 13, 2020Business Insurance
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A surety bond is a form of insurance protection that is essentially a promise by one party to be liable for the debt, default, or failure of another party.

They ensure that a service that is being performed by one party for another party is fully completed. If the service is not completed or is done improperly, then the party that suffers damages due to the service not being completed is fully compensated.

How Do Surety Bonds Work?

Regardless of the specific purpose, a surety bond forms a legal agreement between three parties.

The first party is the principal. The principal is the individual or business who has promised to perform the professional service and is also the party that pays for the surety bond.

The second party is the obligee. The obligee is the individual or business who the service is being performed for and is the one that suffers if the service is not performed properly or at all.

The third party is the surety itself. The surety is the one who provides compensation to the obligee if the principal fails to do what was promised.

Surety bonds guarantee that the obligee will be compensated if harm is inflicted upon them by the principal.

Types of Surety Bonds

There are three main categories that surety bonds can be placed into, and these three categories can be subdivided into thousands of different types of bonds.

Commercial Surety Bonds

surety-bondsCommercial surety bonds are used to regulate markets and keep working professionals from committing fraud or utilizing any other harmful business practices. Most commercial surety bonds are license and permit bonds. As the name implies, these types of surety bonds are required by the government before they will issue licenses and permits.

This is done in an effort to protect the public and prevent the government from losing money. The following bond types are less common examples of commercial surety bonds.

Sales tax bonds ensure that businesses pay all of the required sales taxes to government agencies after a consumer has made a purchase.

Auto dealer bonds ensure that dealerships are following proper government regulations regarding the purchasing and selling of automobiles. They also help prevent shady sales and business practices.

Business service bonds protect clients from financial or property losses that are committed by the employees or owners of a service provider.

Commercial surety bonds are typically very easy to qualify for, as insurance companies view them as being relatively low risk.

Contract Surety Bonds

surety-bond-contractContract surety bonds ensure that contracts are completed according to the legal terms established by the contract. Contract surety bonds are put in place to compensate the obligee for any losses suffered by the contract defaulting.

Contract surety bonds are most commonly used in the construction industry. The federal Miller Act requires that contract surety bonds be used for any construction project that exceeds more than $100,000, though some states require contract surety bonds for projects that exceed as little as $5,000.

The three most common types of contract surety bonds are bid bonds, performance bonds, and payment bonds.

Bid bonds require that contractors enter into a contract if their bid for a project has been accepted by the obligee. If the contractor decides to pull their services after they have won the bid, then the difference between their bid and the next lowest bid will be compensated to the project owner.

Performance bonds protect project owners from a contractor’s failure to complete the task or project in accordance to the specifications put in place by the contract.

Payment bonds ensure that contractors will be the ones to compensate subcontractors, equipment suppliers, and other parties whose services or products are being used to complete the project.

Court Surety Bonds

Court bonds are put in place to reduce the risk of financial loss for a person who is pursuing an action through a court of law. They are also used to ensure the fulfillment of a court-appointed task. The two main types of court bonds are judicial bonds and fiduciary/probate bonds, which can also be subdivided into smaller categories.

Judicial bonds are a type of court bond that is put in place to limit the losses that could result from a judicial ruling. Since judicial rulings are difficult to predict, judicial bonds are more risk averse than other types of surety bonds, making them more difficult to apply for from an insurance company.

Types of judicial bonds include appeal bonds, bail bonds, and plaintiff’s-attachment bonds.

The other variety of court bonds are fiduciary/probate bonds. These types of bonds are put in place to ensure that individuals who have been charged with managing another party’s financials and assets are doing so to the best of their ability.

Types of fiduciary/probate bonds include custodian bonds, executor bonds, and guardianship bonds.

To learn more about how fiduciaries work and what purposes they serve, read our guide about fiduciary responsibilities and the importance of fiduciary liability insurance.

How Much Do Surety Bonds Cost?

The cost of a particular type of surety bond changes depending on who is purchasing the bond and is also influenced by several other factors. Some types of surety bonds are considered to be very low-risk and, therefore, are often assigned a flat fee without any form of financial review.

The trustworthiness of the principal (the party who is purchasing the surety bond) and their credit score is usually taken into account when pricing a surety bond. If you are looking to apply for a surety bond to protect you or your business from harmful practices, contact Cowell James Forge Insurance Group. We can cover any losses suffered by you, the obligee, if the principal does not uphold their end of the bargain.