Surety bonds are one of the best ways to secure your investments in construction business. They protect obligees’ investments and make sure that the project is finished in a timely manner and in accordance with the contract conditions. In legal and finance terms, surety bonds represent a hybrid of insurance and credit. Obligees see surety bonds as an insurance, because they allow them to file their claims if project promise is not met. Principals (bonded companies or individuals) see bonds as credit because if something goes wrong, they are obliged to pay claims to the surety company.
Who sells surety bonds?
Surety bonds are sold by surety companies. These companies usually sell a wide variety of different bonds and they need to be licensed by the Department of Insurance in the state where they operate. Surety companies employ underwriters, whose job is to determine the background and the financial state of a principal company. These professionals also set bond’s prices and additional requirements, like signing an indemnity agreement, in which principals guarantee the surety they bought with their corporate or personal possessions. Indemnity agreements have to be signed by all major shareholders.
Different types of surety bonds
There are different types of surety bonds. Their categorization is based on their purpose, and most surety companies divide them in three groups:
License and permit bonds- are surety bonds required for obtaining active licenses for different types of service businesses. Their purpose is to protect the public that serves as an obligee in this case. There are different types of license surety, depending on company’s industry, including: freight broker bonds, medicare bonds, insurance broker bonds, auto dealer bonds etc.
Contractor bonds- offer classic type of surety, described in the first paragraph. These bonds are required for construction projects, especially those that are paid with public funds. Depending on the phase of project completion, these bonds can be categorized as: bid bonds, performance bonds, supply bonds, maintenance bonds etc.
Other types of surety bonds- offer surety for different types of processes and actions. These include fidelity bonds that protect customers and business owners from employee theft and court bonds that guarantee that court orders will be executed.
How do claims work?
If contract terms haven’t been met by the principals, they are required to pay claims for project completion. Claims can be paid with corporate or personal assets, depending on the contents of indemnity agreement. Principals should never avoid paying claims, because then their bond will be cancelled with no refund and they won’t be able to purchase bonds from any other surety company in the future.
Benefits of surety bonds
Benefits of surety bonds for obligees are obvious. Surety bond guarantees that their project will be finished in accordance with the contract conditions, which means that obligees can’t lose their investment money.
Principal’s benefits in bonding process are much harder to explain. Most contractors view these bonds as an unwanted necessity, because they are obliged to buy them if they want to bid on government funded projects. While focusing on the small amount of money they need to pay to surety company, contractors often forget all the benefits they are getting. If the project goes wrong, they won’t be facing expensive lawsuits or capital claims. They are also allowed to use all of their funds and assets in order to complete the project. Even if the project is not completed, and claims occur, principals are only charged for project completion (plus legal taxes), and surety company’s underwriters and legal team consults and protects them from any further damages.
Surety bonds shouldn’t be viewed as an unwanted necessity, but as a guarantee contractors give to their clients. Although surety bonds are mainly tied to government funded projects, many contractors buy them as a guarantee of their work. This is a very good marketing move, which attracts investors and increases their loyalty.