What Is a Surety Bond?

In short, a surety bond is a type of contractual agreement between three entities or parties:

  1. A principal: the bond policyholder
  2. An obligee: the business or government agency requiring the bond
  3. A surety: the company issuing the bond

While the definition of a surety bond is fairly straightforward, how the three parties are connected by the bond is a little more complex.

How Do Surety Bonds Work?

Surety bonds work as a guarantee or promise that you will conduct your business in an ethical and professional manner. To your customers, it’s an indicator of trustworthiness. Your bond provides them financial recourse if something goes wrong.

To start, the obligee sets the terms of the bond (including the bond coverage amount) and identifies who needs to get bonded. You, as the principal or bondholder, are required to buy and post the bond and honor its terms. The surety backs the principal by issuing the bond for the coverage amount you need.

The coverage amount (also called the penal sum) is how much you can be held liable for if you fail to comply with the terms of your bond. That means your customer can file a claim against you or your business if you don’t deliver on goods or services as promised. If the claim is upheld in court, the surety company will pay the affected party up to your bond’s coverage amount. In return, you will have to repay the surety company the amount paid out to the person harmed by your actions.

What Do Bonds Cover?

Surety bonds are generally considered a promise that you will do what you’re supposed to do—with financial strings to create a strong incentive to fulfill that promise.

These bonds cover a customer’s loss if the bonded person or company was negligent or unable to fulfill the terms of a contract. For example, Contractor Performance bonds are an assurance that the bonded contractor will complete the job they are hired to perform.

Surety bonds also cover a customer’s loss due to unethical business practices or fraud committed by the bond policyholder. A California Immigration Consultant bond, for instance, protects the public from any fraud committed by the immigration consultant.

The details of your surety bond will vary depending on your location, your industry, and the terms set by the regulatory authority. For example, Motor Vehicle Dealer bonds in Colorado, Maryland, and New York are all defined differently—based on the types of vehicles being sold, whether they’re new or used, or according to the reported sales volume from the previous year.

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Who Needs to Have a Surety Bond?

If you’re venturing out on your own, running a business, or providing certain services, you might be required to get bonded.

Most surety bonds are considered license and permit bonds, meaning it’s a requirement of the business licensing or permitting process. If your state or municipality requires you to be licensed in order to do your job or run your business, you may need to have a surety bond.

Depending on your state, some industries, like construction, may require you to post more than one bond. In addition to being bonded at the state level, you may also need a municipal-level bond for the city or county you’re working in.

The regulatory authority that oversees your industry can provide more information about your specific bonding requirements. For example, motor vehicle dealers in New York will find information about bond requirements on the state’s Department of Motor Vehicles website.

 Surety Bonds vs. Insurance

The main difference between surety bonds and insurance is who the policy protects. A bond functions as a form of credit for you, the policyholder, and is intended to protect the public (i.e., your customers) from financial harm. If a claim against your surety bond is upheld, you’ll need to repay your bond provider for the amount they distribute to the claimant.

Insurance, on the other hand, is designed to protect you as the business owner or service provider. If you end up in legal hot water, insurance may provide financial protection by covering costs like your legal fees. Generally, you’ll be covered up to your policy limit, and you don’t pay the insurance company back.

Keep in mind that an insurance policy is no substitute for a surety bond.

What Are Fidelity Bonds and How Are They Different from Surety Bonds?

While a surety bond protects your customers if your actions cause them financial harm, a fidelity bond protects your business. Depending on the details of your fidelity bond, it may cover you if your employee steals from your customer, commits fraud, or embezzles funds from your company.

Fidelity bonds are helpful for situations that your regular insurance policy may not cover. They’re useful for a wide range of businesses, including retail stores, subscription service providers, janitorial services, and so on.

Next Step: Getting a Surety Bond

While the process for buying a surety bond will vary, the basic steps are generally the same.

Find out what you should do to get a surety bond.

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