Surety bonds are similar to both insurance and credit, depending from which perspective you are look at them. To obligees they represent an insurance that guarantees that the project they ordered will be finished in timely manner and in accordance with the contract terms. To contractors, they represent a type of credit, which guarantees obligees’ investment. It is easy to realize that surety bonds are more popular among investors, than among contractors. Reason for this is because many people don’t recognize full scale of benefits this type of arrangement brings to both sides. In this article we will demystify surety bonds and explain the benefits of their use.
Who issues surety bonds?
Surety bonds are issued by surety companies. These companies assign each bond with a price, which depends on project’s worth. For some bonds, contractors are also required to sign indemnity agreement, with whom they guarantee that they will reimburse surety with their corporate or personal assets.
Most surety bonds are easy to purchase. Some surety companies even allow their clients to purchase bonds online. On the other hand, surety bonds that are issued for large government projects, often require corporate or personal guarantees of all contractors and shareholders involved.
Different types of surety bonds
There are many different types of surety bonds, and most surety companies divide them in these three groups:
- License bonds- are protecting the public (which serves as an obligee in this case) from damage caused by service companies. These bonds are required for obtaining work licenses and permits in many different states. They are further divided depending on company’s industry, so there are: insurance broker bonds, auto dealer bonds, funeral bonds, alcohol and liquor bonds etc.
- Contractor’s bonds- protect investors and guarantee that construction project will be finished in timely manner and in accordance with contract terms. Depending on which part of the project completion these bonds relate to, they are further classified as: bid bonds, performance bonds, supplier’s bonds etc.
- Other surety bonds- work on the same principle and cover various different projects and processes. For example there are fidelity bonds, which protect customers and business owners from fraudulent behavior of company’s employees, while court bonds guarantee that convicts will fulfill their responsibilities, ordered by law, state or federal courts.
When do you need surety bonds?
If you want to incorporate a contractor company, you will first need to obtain contractor’s license bond, and present it in front of Contractors State License Board (CSLB) in order to receive an active license that allows you to start this type of business.
From there you will often need to buy different types of contractor’s bonds in order to win various projects. Most big projects require you to purchase these bonds, especially if they are paid from government funds.
Some contractors also decide to guarantee their work with surety bond, even when its purchase is not demanded by investors. This can be a very good PR move, because surety bond provides a guarantee for their work, and it attracts other investors to hire them.
In case contractor is not able to finish the project, surety company pays for project completion and makes claims. These claims can be as large as the full value of the surety bond, and they can be paid by corporate or personal assets, which are cited in indemnity agreement. Although paying claims is definitely not a nice experience, even in this case surety company protects contractor’s interests. Company’s legal team will guarantee that contractor pays only for the project completion and for the damages caused by the delay. This way they protect contractors from capital claims and lawsuits.