Depending on the type of business you want to operate, you might need to get a surety bond. Surety bonds are contracts that function as guarantees that the contractual obligations will be met and that the principal will comply with all of the applicable laws and regulations. Here is some information about surety bonds and when you might need to purchase one.
What Are Surety Bonds?
Surety bonds are legally binding guarantees that the principal will perform its obligations and follow the laws and regulations. They are promises made by surety companies to pay if the principal fails to perform or violates the law. The following three parties are involved in the surety bond process:
- Principal – The party that is required to obtain a surety bond.
- Obligee– The party that requires the principal to secure a surety bond, which is frequently the government.
- Surety – The company that issues the surety bond and guarantees that the principal will perform as promised.
How Surety Bonds Work
Many businesses and licensed professionals are required to purchase surety bonds before they can obtain licenses to operate their businesses. To get a surety bond, the principal will go to a surety company and pay a percentage of the total bond amount upfront as a fee. Obtaining a surety bond is not an automatic process. Instead, the surety company will complete an underwriting process to determine the risk posed by the principal, and principals that are determined to pose greater risks will have to pay a higher percentage upfront or might be denied altogether. The principal is required to sign an indemnification agreement in which the principal pledges its assets to reimburse the surety company if a claim is filed.
Surety bonds are not a form of insurance, but many people mistakenly believe that they are. If a claim is filed against your surety bond, you will be liable to pay the claim. If you fail to pay a surety claim, the surety company will step in and pay it. However, it can then recover what it is owed by seizing your pledged assets or filing a legal claim against you. If you have unpaid surety claims, your surety bond can be canceled. Since many professionals are required to be bonded for licensing, losing your surety bond could force you out of business.
Common Types of Surety Bonds
There are many different types of surety bonds used for different purposes. However, the following three types are the most common ones:
- License and permit bonds – These are surety bonds required for different professionals before they can legally operate and obtain licenses.
- Contractor bonds – Contractor bonds are surety bonds required by the government for contractors that will perform work on public construction projects.
- Court bonds – Court bonds are bonds required by courts for different purposes.
How Much Do Surety Bonds Cost?
The amount you might have to pay to secure a surety bond will depend on several factors and can range from 1% to 15% of the maximum bond amount. The surety company will consider multiple factors during the underwriting process, including your credit history, your available working capital, your experience, your reputation, and your history with surety bonds to determine whether to issue a bond and the percentage you will have to pay as an upfront fee.
When Do You Need to Get a Surety Bond?
Contractors that want to work on government contracts are typically required to get surety bonds. In addition, one of the requirements for government contractors when they want to get a contractor’s license is to have a surety bond in place.
Many different types of professions that require licenses also require people to get surety bonds before they can obtain their licenses. Even when getting a surety bond is not legally mandated, many people and companies require those companies and individuals they hire to perform work to be bonded. This is because surety bonds compensate consumers when the principals fail to perform under their contracts. Lenders within the construction industry frequently require that the contractors have surety bonds before they will approve them for financing.
Some examples of the types of companies that are required to get surety bonds include the following:
- Construction companies
- HVAC companies
- Auto dealers and dealerships
- Debt collectors
- Health and fitness clubs
- Mortgage brokers
- Travel agencies
- Notary publics
- Medical equipment companies that contract with Medicare
You can check with the Secretary of State’s Office in your state to determine whether or not you are required to get a surety bond to obtain licensure or to operate your business.
How Long Do Surety Bonds Last?
Surety bonds do not last indefinitely. When you purchase a surety bond, it will have a bond term. The bond term tells you the duration of the bond. Many surety bonds last from one to four years. If you operate a business in an industry that requires a bond for licensure, you should ensure that your surety bond does not lapse. It is possible to renew your surety bond through the surety company that issued it.
Surety companies can also cancel surety bonds when the principal has a history of multiple claims filed against the surety or has failed to pay a claim filed against it. If your bond is canceled by your surety based on your history of claims, you will likely have trouble securing a new bond from a different company. Once you purchase a surety bond, you need to ensure that you perform your contractual obligations and comply with the laws and regulations that govern your industry. This can help you to build a good history with your surety and protect your business’s reputation and ability to operate.
The necessity of getting a surety bond is just one of the many things that you might be required to do as a cost of doing business. If you learn that you are required to get a surety bond, you can apply at a surety company. Once you secure your bond, you can then apply to get your license, bid on public contracts, and move forward with your business. Make sure to operate your business in an above-board manner to avoid potential claims against your surety.