Many people have no idea what a surety is or how it works. The truth is they can be a significant asset for construction companies, auto dealers, and many other professions. Surety bonds are a kind of insurance that limits the financial risk of certain projects. They have many applications and a surety can protect private companies, public tax dollars, and customer spending.
These types of bonds can be used in many different ways, but they do all have some things in common. Every surety bond has three parties that are joined by a legally-binding agreement.
- The Principal: This is the person or business that buys the bond as a guarantee of a professional service.
- The Obligee: They are the party that requires the bond to protect their investment. Having this contractual promise protects them from loss and minimizes their risk.
- The Surety: This is the insurance company that supports the principal by underwriting the bond.
When the principal fails to follow through on the obligations of the bond, the obligee is allowed to make a claim. If the claim is ruled valid, then the surety insurance company will deliver compensation up to the amount of the bond. Actual bond claims are rare because surety agencies do thorough research into the principals before they decide to support it. When surety claims are made to payout, the insurance agency does force the principal to repay them in full.
Common Types of Surety Bonds.
There are many different types of these bonds because government agencies have regulations that need unique forms of surety bonds. Getting a construction surety bond in Texas can differ significantly from the same bond in another state.
- Commercial Bonds: If a private business needs a bond for their own operations, they will probably need this type of bond. These bonds discourage other principals from committing fraud or other unethical practices. Commercial bonds are required by the government before they will issue certain licenses or permits.
This practice protects the government and helps to regulate the market. This method covers bonds for auto dealers, Medicare, contractor licenses, sales tax, and mortgage brokering.
- Contract Bonds: Simply put, these bonds ensure the terms of a contract. No one wants it to happen, but principals do default on contracts from time to time. Surety bonds will protect business owners from losing all of the investment they made into a project. These surety bonds work mainly in the construction industry. The federal Miller Act forces the use of surety bond companies on all publicly funded construction projects. Many states will have different rules for construction bonds in their own regions.
- Court Bonds: These bonds defend businesses and individuals from criminal or civil legal charges. There are appeal and guardianship bonds that enforce original judgments and court expenses are paid appropriately. This type of bond is all about ensuring the payment of judgments or the right distribution of things like assets after a person’s death.
The Costs of Surety Bonds
How much a surety bond costs can vary widely depending on the industry they are in and parties involved. Bond prices are affected by things like the size of a project, personal credit scores, and state regulations. The basic structure is a small percentage of the coverage required. For instance, a $50,000 bond could cost anywhere from $500 to $2000 based on the qualifications of the principal trying to get the bond. Applicants will lower credit scores will have to pay even higher bond rates.
There are many different types of these bonds, and they can apply to several different industries. To understand surety bonds, the most vital parts to remember are that is a contractual agreement between three parties trying to complete a project. An insurance or surety agency is there to reduce the risk of monetary loss by the project owner in case the principal or service provider defaults on their services. It is a type of protection that helps all three parties. The surety gets new business, the principal ensures their methods and practices, and the obligee gets to protect their investment.