GENERAL INDUSTRIES | CLIENT RESOURCE
What they are and why you should consider them for your commercial clients
May 2021 | General Industries
BY JEFF COSE
Surety bonds can be an overwhelming topic for businesses, particularly if they are new to the process. In basic terms, a surety bond is an agreement between three distinct parties: an obligee, a principal and a surety. Each party plays a key role in the agreement as follows:
Put simply, surety bonds can be thought of as a written agreement to guarantee compliance, payment or performance of an act.
It is important to note that surety bonds are not insurance, but rather assurance. Unlike insurance, a surety bond is a three-party agreement that guarantees performance. While insurance policies provide a payout to the insured following a loss, surety bonds are more similar to financial instruments, essentially acting as credit that functions on the premise that no losses will occur. If a surety does not believe a principal can perform their tasked duties, the surety will not issue a bond. In some cases, both bonds and insurance may be required for a given project.
There are thousands of different types of surety bonds. Some surety bonds provide coverage for — or ensure compliance with — local, state or federal licensing and permit requirements. Other surety bonds guarantee payment of tax or other financial obligations. For the purposes of this article, we will examine the three main types of surety bonds: contract, commercial and fidelity surety bonds.
During construction projects, project owners want to trust that the contractors they’ve hired will complete work on time and as agreed upon. While traditional contracts are often used to lay out specific requirements for both contractors and subcontractors, the terms and conditions of these contracts can be broken. When this happens, project owners may be left with unfinished work. That’s where a contract surety bond can help.
As they relate to construction projects, contract surety bonds ensure that obligees will be made whole following uncompleted projects. This can involve financial compensation or a promise that any incomplete work on a project will be completed.
Contract surety is common, and it is used to protect an obligee if a contractor fails to fulfill the duties outlined in a contract. There are several widely used contract surety products, which are generally utilized before a project bid, during a bid or during the project itself:
Contract bonds may also be required to support principals and contracts not related to the construction industry.
Commercial bonds are often required by governmental bodies or industry legislation. They are also frequently purchased by companies or professionals in compliance with state licensing and permit regulations, guarantying some aspect of a principal’s occupation. The type of commercial bond purchased will depend on the work the principal will be performing.
License and permit bonds are the most common. They are required by state, municipal, or federal ordinances and regulations. Specifically, these bonds may be required in certain industries or occupations before an individual or entity is granted a professional license (e.g., contractor license bonds, electrician bonds, HVAC commercial bonds, nonresident license bonds and plumber bonds). Above all, commercial bonds are meant to protect the consumer, ensuring that any work a contractor does is up to code.
Another common subcategory of commercial bonds includes court and judicial bonds. These bonds can be required of plaintiffs or defendants in judicial proceedings and are used to preserve the rights of the opposing litigant or other interested parties. For example, imagine a party was sued and had a judgment placed against them. To go through the appeals process, the party would have to put up an appeal bond for the amount of the judgment. Effectively, the bond is used as a stopgap measure and guarantees that, if the appeal is denied, the party that wins the judgment gets their funds immediately.
Other common types of commercial surety bonds include sales tax bonds and auto dealer bonds.
Unlike contract and commercial bonds, fidelity bonds effectively are forms of insurance. Specifically, fidelity bonds protect employers against losses caused by the fraudulent or dishonest acts of their employees. Typically, if an employer trusts one or more employees to handle cash or other valuable assets, they should consider a fidelity bond. There are several different types of fidelity bonds, including business services bonds, standard employee dishonesty bonds and Employee Retirement Income Security Act of 1974 (ERISA) bonds.
For businesses new to the process, becoming educated on and purchasing surety bonds can be overwhelming. That’s why it’s so important to partner with organizations that have proven surety bond experience and expertise. Established, highly rated partners can not only help issue small bonds quickly (sometimes in minutes), but they can also think outside of the box to provide customized surety solutions and programs.