What is a surety bond?

What is a surety bond?

March 02, 2022
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If you’re not familiar with the added protection a surety bond provides, you can easily be put off by a request that you obtain a “bond.” It’s a standard practice in the construction industry where there’s potential for work-related injuries, weather delays, performance issues and more. Surety bonds protect you and the project owner against unforeseen situations that may arise during a project. 

Surety bonding provides coverage in the event that: 

  • You fail to complete the project as contracted 
  • You do something to jeopardize the project 

The number of fields requiring bonds is growing rapidly. The guarantees provided by surety bonds can help you open up bigger contracts and new markets for your business. 

A three-party contract 

A surety bond is not an insurance policy. It’s a three-party contract that guarantees you will complete the work according to the timeframes and costs outlined in a construction agreement. 

Surety bonds (or “contracts of suretyship”) involve: 

  • Principal: The one contracted to provide a service and the one who buys the bond 
  • Obligee: The project owner who requires the guarantee of the bond 

  • Surety: The entity providing the financial guarantee the principal will perform as required 

If for some reason you fail to fulfill your obligations as the principal, the surety must respond to the obligee by finding alternative means to fulfill the contract or by compensating for financial losses incurred. 

The cost you will have to pay for the bond will depend on the type of bond and the risk level of the project. In general terms, surety bonds cost between 1% and 15% of the value of the bond. 

Types of bonds 

There are several types of bonds you may be required to obtain, including: 

  • A bid bond to guarantee that the successful bidder will enter into a contract with the project owner (On rare occasions, a successful bidder will decide not to follow through with a contract because of changed circumstances or errors in developing the bid.) 
  • A performance bond to ensure that a project is completed on time and according to specifications 
  • A payment bond to guarantee all of a project’s bills for labor, materials, and services have been paid, and that the project is then free from all liens 
  • A maintenance bond to guarantee that the project will be free of defects for a specified period after it is completed 

While these types of bonds have long been standard requirements of public works projects, they are being required on more and more private projects, and in areas of commerce other than construction. 

Since 2004, the Surety Association of America (SAA) has been tracking “non-construction contract performance bonds,” a new category of surety bonds that has grown 700%. 

This category includes service and supply bonds, surety contracts guaranteeing that suppliers, distributors, manufacturers, and service vendors will provide goods and services in accordance with contractual commitments. Service and supply bonds play a vital role in helping organizations address disruptions to complex supply chains. 

Licensing and permit bonds 

You don’t need to be a major contactor or vendor to be required to provide a surety bond. 

States and municipalities often require business owners to provide permit or compliance bonds as a condition for receiving a business license. Compliance bonds guarantee licensees will comply with all applicable codes while doing business. 

License and permit bonds are commonly required of: 

  • Artisans: carpenters, electricians, plumbers, etc. 
  • Personal services providers: hairdressers, manicurists, masseuses, etc. 

Among other things, compliance bonds strengthen the enforcement of business codes. Surety companies have a direct financial interest in seeing that their principals comply with the law. This benefits business owners and the public. 

Benefits of being bonded 

Being bonded can improve your reputation within the business community. It demonstrates that you are a responsible contractor. Along with establishing yourself as a solid business partner and receiving contractual guarantees, other benefits of being bonded are:  

  • Access to technical assistance and professional advice from lawyers, accountants, engineers and other professionals through your surety  
  • Protection in the event of a dispute with a project owner  
  • No security (or upfront deposit) requirement   

Surety bonds lessen risk, and they offer advantages for all parties in the contract.  

As you consider becoming bonded, review your financial records, operation plans and business relationships to ensure they are all in order. Sureties will review all of those as part of the qualifying process before approving you for a bond. Contact your insurance professional to see if they provide surety bond assistance or can refer you to someone who does.