Understanding 4 Types of Surety Bonds
Understanding 4 Types of Surety Bonds
There are many types of surety bonds, and there is no official or legal way that they are divided into categories. However, to understand surety bonds, it may be helpful to break them down into four categories: contract bonds, judicial bonds, probate court bonds, and commercial bonds.
In addition to these four categories, it's important to understand the basics of what surety bonds are, as well as how to obtain them.
Surety Bond Basics
A surety bond is an agreement among three parties, who are identified by the following terms:
- Principal: a party that has a responsibility to perform some obligation
- Obligee: a party that will benefit from the principal's performing the obligation
- Surety: the party that promises to pay the obligee if the principal fails to perform the obligation
The amount that the surety promises to pay is called the penal sum. Since a surety bond is only as good as the solvency of the surety, this is usually a professional bonding or insurance company.
A surety bond is somewhat similar to an insurance policy. The principal pays a fee, called a premium, to the surety. Obtaining a surety bond provides an additional incentive for the obligee to trust the principal. In the event of default, the surety pays the penal sum to the obligee, and then seeks reimbursement from the principal.
State laws regulate surety bonds, and federal law also may come into play if federal funding of a project is involved.
Contract Surety Bonds
A contract surety bond serves as an inducement for the obligee to enter into a contract with the principal. Contract surety bonds are often used in the construction industry, and come in several variations:
- Bid bonds guarantee that a contractor who puts in a bid will enter into a contract if the bid is accepted.
- Performance bonds guarantee that the contractor will fulfill the terms of the construction contract.
- Payment bonds guarantee that the contractor will pay subcontractors. Subcontractors also may be required to get bonded.
- Supply bonds guarantee that the contractor will pay the suppliers of materials.
- Maintenance bonds guarantee that the contractor will fulfill any requirements relating to repair and upkeep once the construction is completed.
- Improvement bonds, also known as subdivision bonds, are often required by municipalities for subdivision developments.
Judicial Surety Bonds
Judicial bonds, also known as court bonds, are used in a variety of situations involving court proceedings. In a criminal case, there are bail bonds, which secure the appearance of the defendant for trial or other future proceedings.
There also are several types of judicial bonds for civil cases, which include:
- Appeal bonds, also called supersedeas bonds, protecting the party that won in the original proceeding for damages resulting from the delay caused by an appeal by the losing party
- Mechanic's lien bonds, protecting a defendant for damages resulting from a mechanic's lien
- Attachment bonds, protecting a defendant for damages resulting from a property attachment
- Injunction bonds, protecting a defendant for damages resulting from an injunction
Probate Court Surety Bonds
A person appointed as a trustee, guardian, executor, or administrator in a probate proceeding has a special obligation to perform their duties with honesty, loyalty, and good faith. This is called a fiduciary duty.
A probate surety bond, also known as a fiduciary bond, guarantees that the trustee, guardian, or executor or administrator of an estate, will properly perform their fiduciary duty to the beneficiaries.
Commercial Surety Bonds
A commercial surety bond is a general category for various bonds that do not fall under one of the other categories. Sometimes, judicial and probate court bonds are included in this category.
License and permit bonds are often required by governments if some type of license or permit will be issued. To give a few examples, a bond might be required to obtain a business or professional license, to ensure compliance with regulations regarding employee retirement plans, to ensure compliance with environmental protection regulations, or to ensure payment of business-related taxes.
Public official bonds may be required of public officials, such as notaries public, government officeholders, judges, or law enforcement officers.
Business service bonds, or fidelity surety bonds, are used to protect the clients or customers of a business from actions by employees of the business. For example, a business that provides office cleaning services may get bonded to protect against theft or property damage by its employees. Or, a brokerage or financial advisory company may obtain a fidelity surety bond to protect itself and its clients against employee embezzlement.
Other types of surety bonds may be used in a variety of situations. For example, surety bonds may be used to establish lost promissory notes and securities, or to guarantee self-insurance of a company for workers compensation claims or employee fringe benefits. A tenant in a commercial lease also may be required to have a surety bond.
Obtaining a Surety Bond
Obtaining a surety bond typically involves some type of background check of the individual, the business, or both. This often involves examination of a credit report and the provision of company financial information. Both the bond amount and the premium will be determined by the creditworthiness of the principal. The type of bond and nature of the business also may be factors.
A bond premium typically ranges from 1 percent to 15 percent of the bond amount. Premiums are typically paid annually. Some business surety bonds may be guaranteed by the U.S. Small Business Administration, which will result in an additional fee, but may make it easier for the company to obtain a bond.
Some bonds are required by contract, and others are required by law. Regardless of which type of bond is needed, a surety bond is almost always obtained from a professional bonding company.
By being familiar with the different types of surety bonds that are available, you'll be better prepared when a situation arises in which you need the protection a surety bond provides. For more information, you may wish to consult with an attorney, to learn more about the specific rights of the principal, obligee, and surety.