Surety Bonds for Dummies
In essence, a surety bond is a contract between three parties which is legally binding and is entered into by the three parties for the purpose of protecting one of the parties against poor performance or non-compliance by the other party. These three parties are the principal, the obligee, and a surety company. The principle is that an individual who is required to purchase the bond and is generally a construction contractor or a person seeking to obtain a business license for the state he/she resides in.
The obligee is the party that requires the principal to purchase the bond, typically a government agency that is responsible for the regulation of a specific industry. One example would be a state Department of Motor Vehicles organization which requires an auto dealer to purchase a surety bond before opening for business in the state.
The surety company, which is sometimes also referred to as the bonding company, is the party that assumes the risk by providing financial backing for the surety bond. When a bond is sold to a principal, the surety provides full financial backing for the entire amount of the bond, in the event that an obligee chooses to make a claim against the bond. In order for a surety company to take on this risk, the principal would have to pay a premium amount to the surety, to secure that financial backing.
How do bonds work for dummies?
Some people confuse surety bonds with insurance, and although there are some similarities between the two, there is also one huge difference. An insurance policy will always protect the party who owns the policy, whereas surety bonds protect the party which requires the principal to purchase the bond. In many cases, the surety bond also serves to protect the public against some violation of the terms of the bond.
For instance, in the case of a simple licensing bond, the public is protected against any kind of fraudulent activity by an auto dealer who is required to purchase the bond. In this case, the state Department of Motor Vehicles is not given any protection by the bond, but it doesn’t really need any protection – it merely requires the auto dealer to purchase the bond as a means of providing some level of compliance for auto buyers.
In the event that a principal does not live up to the obligations and the stipulations noted in the terms of the bond, a claim may be filed against that principal by the obligee. Assuming the claim is found to be valid, the surety company would then have to step in and pay an amount up to the full face value of the bond. When that claim is fully resolved, the principal would then be obliged to compensate the surety company for the entire amount provided.
Who benefits by surety bonds?
In actual practice, surety bonds benefit all three parties in the agreement. The surety company, of course, can make a small profit by selling the bond to a principal, so it benefits by increased business. The obligee or the public interest is protected against fraudulent activity or non-compliance by the principal, so there is a definite benefit to both parties.
It may not seem like the principal derives any benefit from having to purchase a surety bond, but there are in fact some advantages which accrue to the principal who purchases the bond. First of all, in the case of a construction contractor who is required to purchase a surety bond, having that bond will allow him/her to compete against other contractors who are also likely to be bonded.
In the case of any business person who acquires a licensing bond, it will allow that individual to conduct business within state borders, so this can be seen as a definite benefit to the bond purchaser. Another rather subtle way that principals benefit by purchasing a surety bond and having a legal agreement with the surety company, is that when a claim is made, the surety company will always assign a team to investigate the validity of that claim. In this sense, the surety company acts on your behalf and as your advocate, ensuring that any claim made against the bond is valid before deciding to pay the amount of that claim.
Different Types of Surety Bonds for Dummies.
One of the most common types of surety bonds is license and permit bonds, which are also sometimes called commercial bonds. These types of bonds constitute licensing requirements for a great many businesses and industries, for example, contractors, mortgage brokers, auto dealers, and freight broker bonds. They guarantee that the business owner will operate in accordance with the regulations and rules governing their specific type of business license.
Court bonds generally deal with guardianship issues or someone’s estate, and they generally guarantee the court that any appointees will act in the best interests of a ward, and any funds associated with these two areas will be dealt with appropriately. Within the broad category of court bonds, there are guardianship bonds, appeal bonds, and fiduciary bonds.
Fidelity bonds are the type which is closest in nature to insurance, partly because they are optional in nature, and because they do provide protection to a business owner rather than an obligee. A business owner who purchases a fidelity bond is seeking protection against employee theft or dishonesty. These kinds of bonds are very popular with financial institutions where a great deal of money is involved, and also among businesses that perform any kind of maintenance to a client’s property, e.g. cleaning services.
Contract bonds provide assurances to a project manager that a specific project will be finalized in total compliance with state and federal regulations, as well as any detailed terms are written into the bond itself. The different kinds of contract bonds protect the project owner or the government (when it is awarding the contract), in addition to all those parties who sub-contract work out from a general contractor. Within the general category of contract bonds, there are performance bonds, bid bonds, payment bonds, and maintenance bonds, but all of these are associated with a single contract on a specific construction project.