Surety bonds can be confusing. With multiple names for the same type of bond, hundreds of specific-use bonds for different scenarios, and state and federal requirements that aren’t always the same, figuring out which surety bond (or bonds) you need can be a headache.
But there are a few basics that are helpful to know.
For instance, regardless of what type of surety bond you’re talking about, they’re all binding legal agreements between three parties: the principal, obligee, and surety.
The principal party is the business (or individual) who is promising something, whether that be to perform a service, to operate their business according to the law, or to oversee someone else’s financials ethically. The principal is the party that pays for the surety bond.
For example, a construction company may be the principal party that’s promised to build something. Or it can be a company that has a 401k plan that they is required to hold a bond of 10% of the amount in order to protect against use of the funds for anything other than the 401k.
The obligee is the business or individual to whom the principal has made their promise. The obligee is the party that will suffer if the principal does not carry through on their promise.
In the first example above, the real estate company that has hired the construction company to build a new apartment complex is the obligee. In the second example, the company employees are counting on the 401k money to be in the fund and do not want that money embezzled.
The third party in the surety bond triangle is the surety itself. In other words, the surety is the entity that will provide the compensation should the principal not follow through on what they’ve promised.
In the examples above, we mentioned two types of surety bonds – Contract and Fidelity. Commercial bonds are another common type of surety bond.
Let’s break them down.
Contract Bonds
(Commonly needed for contractors, construction companies, commercial landscapers, food services, manufacturers, wholesalers)
Contract bonds are exactly what they sound like. They back up a promise (i.e. contract) between two parties. They’re designed to compensate the obligee if the principal fails to do their job.
While Contract surety bonds can be used in any industry, they’re most common in the construction industry, partly because they’re required on a state level for any project over a certain amount. There’s also a federal act (the Miller Act), that requires a contract bond for any construction project worth more than $100,000.
There are three main types of Contract bonds: Bid Bonds, Performance Bonds, and Payment Bonds.
They’re all relatively self-explanatory.
A Bid Bond guarantees that the entity making a bid on a project will enter into a contract should they win the bid.
A Performance Bond guarantees that a business or individual completes the project they’ve agreed to do in accordance with any specifications in the contract.
A Payment Bond guarantees that the business or individual doing the project will also be the entity to pay any suppliers, subcontractors or other parties whose services are being used to complete the project.
Let’s go back to our first example above – the construction company. With a large project, like a multi-building apartment complex, a construction company may very well have to take out all three types of contract bonds to: 1. ensure it takes the job if its bid is accepted, 2. finishes the job in the manner and up to the standards that have been dictated, and 3. pays all subcontractors and suppliers that were involved in completing the project.
Commercial
(Commonly needed for contractors, construction companies, electricians and plumbers, retailers, car dealerships, banks, healthcare facilities, insurance companies, power and utility companies, telecommunications industry, transportation companies, manufacturers)
Commercial surety bonds are used to ensure that professional entities act, well, professionally and ethically.
The vast majority of Commercial bonds are License or Permit bonds and you’ll often hear the terms used interchangeably. There are dozens of types of these bonds. The construction company in the examples above, for instance, needs a construction license. So do plumbers, electricians, office cleaning companies, garbage haulers, etc.
Other types of Commercial bonds include Sales Tax Bonds and Car Dealership Bonds. These types of bonds ensure that businesses do everything the law requires them to do – like pay sales taxes or honor car lemon laws.
Back to the construction company example. To be a legally-recognized business, the construction company must be holding a license bond (the amount of which is determined by the state or states in which the company works). If the company is subcontracting the plumbing or electrical work, those entities need their own licenses as well.
Fidelity
(Commonly needed by banks, stock brokerages, financial planners, insurance companies, janitorial or maid services, home care and in-home nursing services, retailers, pension trustees, estate custodians or executors)
Also called “honesty bonds,” Fidelity bonds are used to protect individuals and businesses from the dishonest or fraudulent acts of others, including their own employees.
They’re mostly commonly used by businesses whose employees are in a position to act fraudulently or commit theft, and by individuals who have been charged with managing another person’s financials.
The first type of Fidelity bond is most often held by banks, stock brokerages, financial planners, and insurance firms. Businesses like commercial janitorial or maid service companies also might hold a fidelity bond to protect themselves if an employee steals from a client.
Related to fidelity bonds, are ERISA bonds, which are specifically for employees who manage or have a fiduciary responsibility for a retirement fund. (ERISA is an acronym for the Employee Retirement Income Security Act of 1974.) They are almost always required by law and must be equal to no less than 10% of the value of the plan – with a maximum amount of $500,000 for every employee with access to the retirement plan.
Another of type of fidelity bond (sometimes called probate bonds) are custodian bonds, executor bonds and guardianship bonds.
Interested in a commitment-free demo? Call (332) 240-5595 or e-mail danny@propellerbonds.com to see just how easy it is to add surety to your agency’s line of business offering!
