Surety Bonds in Business: Safeguarding Your Interests
While insurance provides broad protection, bonds are more specific in their coverage. Bonds are more like a credit line than an insurance policy and are often shorter-term compared to traditional bank guarantees.
When a client (the obligee) claims the bond, the surety company typically fulfills the obligation or compensates the obligee financially. While claims are rare, there are multiple reasons why business owners need to secure surety bonds.
Licensing and Permits
Many people don’t think much about being bonded until they are told they or their business must do so for some professional or legal reason. So, what is a surety bond? A surety bond is a contract that guarantees the fulfillment of a commitment. It involves a three-party agreement between the principal (person or company needing the bond), the surety company and the obligee.
It is an incredibly unique and special type of insurance that protects individuals, businesses and public entities from financial loss due to the actions or non-performance of the insured. Just as liability insurance protects your business against property damage and workers’ compensation protects employees, surety bonds guarantee that clients receive financial reimbursement should a bonded professional fail to complete projects or adhere to the terms of contracts.
Larger clients or government agencies often require proof of a bond before a company can begin work on a project. State laws may also mandate certain professions carry a particular bond amount. The surety agrees to reimburse the obligee up to the bonded amount. To become connected, the principal must meet the underwriting criteria, including the capacity of the company to perform on contracted projects and its character and reputation. Small businesses can sometimes get a contract surety through the Small Business Administration, which backs between 80% and 90% of the bond amount.
Contracts and Agreements
Contract surety bonds guarantee that businesses will meet the terms of specific contracts. For example, if your company wins a bid for a construction project with a government agency, that entity may want you to have a contract bond before the work begins. That means the bonding company, or obligee, will reimburse your client if you fail to complete the project on time or by local regulations.
A bonding provider underwrites these types of bonds, and various factors are considered, such as your business’s financial strength, credit history and internal management practices. Other common types of surety bonds include license and permit bonds, warehouse bonds and customs bonds for importing goods, and fiduciary bonds to guarantee the honesty and faithful performance of individuals in positions of trust. The Small Business Administration guarantees several contract surety bonds for a fee. Other specialized surety bonds exist to cover more specific situations.
Like insurance, a bond protects customers against financial or legal consequences from your business. For example, if you are a contractor and your work does not meet the standards set by local or state inspection agencies, a customer could file a claim against you to recover their losses. If true, the bonded company will cover the costs up to the bond amount. Bonds are required for certain professions, including commercial building contractors and electricians.
They can also cover warehouse companies, auto dealers, lottery ticket sellers and fuel suppliers. Other specialized bonds are available for mortgage brokers, fiduciaries, travel agencies and agricultural businesses. A bond is a contract between the principal (your business), the obligee and the surety. The latter is the entity that guarantees the work will be performed according to the bond terms. This is different from a regular insurance policy, which involves reimbursement after a claim is made.
Businesses need insurance for various reasons, including liability protection, property damage and workers’ compensation. But unlike the traditional insurance policy, which provides coverage against losses, a surety bond involves a three-party agreement that holds one party responsible to another for specific obligations. That obligation could be compliance with laws and regulations, fulfillment of a contract or fulfilling a professional requirement.
Having a surety bond in place helps reassure your clients that you will honor those commitments and can help you avoid legal or financial issues if something goes wrong. The cost of a surety bond depends on your business and personal credit, so you want to work with an agency that makes it easy to apply and offers competitive rates for applicants of all shapes and sizes. Look for an agency that evaluates technical skills, internal management records, accounting statements, and the business owner’s credit history. You may also need to provide collateral or a co-signer to secure a bond.