What are surety bonds and when to use them?

Wednesday, March 23, 2016, 6:00 PM | 2 Comments

In broad terms surety bond is a bond that ensures that some contract will be completed or some service will be paid. These bonds can be purchased from surety companies.

In case that contractors aren’t able to fulfill their part of the contract, surety companies either find a new contractor or compensate the project owner. This way, project gets done right and in timely manner.

Companies that get surety bonds need to abide to all of their terms. If they don’t do that, they might face surety company’s claims.

These claims force them to pay all money they owe as well as all legal costs, because surety bonds depend on indemnity agreements that pledge company’s corporate assets.

In this relation surety companies guarantee their protégée will abide all contract terms, since significant part of its money or equipment is pledged to them. If by any chance surety company is not able to charge their debts from contractor, they are obliged to pay obligee’s claims themselves.

  • Different types of surety bonds

    There are different types of surety bonds depending on which type of contract or service they ensure or which part of the project or completion process they apply to. The most common type used in business are contract surety bonds.

    These bonds are mainly used in construction and they can be divided into several groups:

    1. Bid Bond– this bond guarantees that bidder will enter the contract and furnish the required payment;

    2. Payment Bond– this bond relates only to payments that contractor needs to make to suppliers and subcontractors;

    3. Performance Bond– this bond ensures that project’s performance will be done according to the contract and that all terms and conditions are going to be fulfilled;

    4. Ancillary Bond– this bond only ensures integral contract requirements and it is not performance related.

    Other than contract bonds, there are lots of other types of bonds surety companies offer.

    These are often classified as commercial bonds, which can be further classified as:

    1. Court surety bonds– that protect parties from losses they might suffer from a court decision;

    2. Fidelity bonds– these bonds ensure companies from employee theft, and in most cases cover the damage employees cause to companies as well as to customers;

    3. Public official bonds– these bonds guarantee that politicians and other public officials will do their job honestly and faithfully.

  • SBA jumps in for the rescue

    Contract bonds are the most common type of surety bonds and for contracts that are being agreed between small businesses, SBA offers mediation services.

    According to federal legislature, every contract that’s exceeds $150,000 require surety bonds purchasing and the same goes for most state and local projects.

    When it comes to small businesses, US Small Business Administration guarantees a bond for contracts worth up to $6,5 million (or $10 million in some cases). In this case SBA mediates between small and emerging businesses and regular surety companies.

    Of course SBA doesn’t do this free of charge (accept in the case of bid bonds). They charge 0,729% of the project’s worth from small business they are representing for payment and performance bonds and they charge 26% from surety company’s commission.

  • Bottom line

    It is much better when surety company is making a guarantee in your behalf, because you don’t need to tie your liquid cash to the project, which then you can use if something goes wrong.

    Surety basically works like a loan, and therefore enables companies to use all of their funds to provide better service. Surety companies in this arrangement act as partners, which means they can protect companies from false claims that can easily lead to bankruptcy.

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  1. 2 Responses to “What are surety bonds and when to use them?”

  2. By Laurie on Mar 30, 2016, 8:46 am | Reply

    If you are hiring a contractor, besides being bonded I would recommend that you ensure that they are properly licensed and insured. Great information on the different types of surety bonds, thanks for sharing.

  3. By LNweaver on Jul 17, 2017, 8:43 pm | Reply

    That’s interesting that surety bonds are used to ‘ensure’ a given performance. I can see how that could be important with building projects; a firm could stand to lose a lot if their contractor fell through. It’s kind of like insurance, but with three parties.

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