contract
Finance

What is a Surety Bond?

Despite surety bond’s prevalence, there are a lot of people that are still confused about how a surety bond functions. But despite the confusion, one thing is for certain, no one can deny that a surety bond is a well-established part of any industry that requires it. And there are plenty of them.

For instance, a person who is applying to become an auctioneer will be required to submit and maintain a sufficient surety bond. Failure to do so will lead to non-issuance of an auctioneer’s license.

A surety bond is also required of contractors who are bidding for a project, whether the construction project is a private or a public one.

It’s safe to say that surety bonds are indispensable and truly valuable protection tools. To further understand why this is so, we will delve into not just the what, but the who, why, and how of surety bonds as well.

 

What is a Surety Bond?

Surety bond is a written tripartite financial agreement and risk-transfer mechanism. The three parties involved are the Principal, Obligee, and the Surety.

The principal is the party who will purchase the bond and who is required to perform the obligations set forth in the bond.

The obligee, on the other hand, is the party that requires the principal to furnish a surety bond and is also the bond’s beneficiary.

The surety is the party that guarantees the faithful performance of the principal to the obligee. If the principal fails to perform the obligations, the obligee will have the right to file a claim against the surety bond.

Because of the surety’s right of subrogation, the surety will have to step into the shoes of the principal when such claim arises. Once the claim has been verified and paid, the surety will have the right to recover the costs of making such payment.

 

Understanding the role of the Surety

Being a surety is no easy task because the surety will assume the dangers that is inherent in answering the obligations of another. Even Greek philosopher and mathematician Thales of Miletus said the “suretyship is the precursor of ruin.”

Because of this, the principal’s qualifications to perform will be assessed as well as the terms and conditions of the bond.

Each principal will go through the prequalification process or what is known as underwriting. An underwriter will rigorously check the principal’s business or job performance history, credit score, and financial capacity.

An underwriter will assess whether the principal will be able to finish the obligations without hindrance or delay.

A surety will also check the underlying statute, regulation, or agreement upon which the bond is conditioned. This is especially true of bonds that are required by law. The surety will have to study the underlying law because there are cases wherein the clause stated on the bond is different from what’s mandated by a statute.

A surety will not be able to understand the extent of the conditions without first studying the law that requires it. In addition, a statute cannot be changed by the protective conditions that are built into the bond.

The Law of Surety Bond was derived from these three English laws: Common Law, Equity, and the Law Merchant of London.

Basic laws of a suretyship includes the following:

  • All parties to the bond must have fair and honest dealing.
  • If the obligee or principal conceals material facts or if there is a fraudulent collision between the obligee and the principal with the intent of hurting the surety, the surety will have the right to be released from obligations.
  • Before a principal or obligee can alter the terms of the bond, they must first inform the surety.
  • The surety will have the right to indemnity.
  • A badly worded contract is not acceptable. An ambiguous contract will be construed to the party who drew it.
  • In case of two sureties, the surety who paid for a claim is entitled to the contribution of the other surety.

 

How much should the principal pay for a surety bond?

This will depend on the bond amount required by the obligee and the principal’s credit score. The amount will not be the same for all principals since the bond amount required varies per industry.

The amount that the principal must pay the surety is known as a bond premium. If the principal has an excellent credit score, the said person will only pay 1% of the bond amount as premium.

Let’s take the case of a Paid Solicitor (principal) who is applying for a license. In some states, the bond amount required by the Secretary of State (where the principal is located) is $10,000. If the said principal has an exemplary credit score, he or she will only need to pay the surety $100 as bond premium!

Contrary to popular belief, a bond premium is not a recurring monthly fee. Depending on the validity of the bond, the principal will only need to pay a bond premium during the initial application and succeeding bond renewals. However, there are bond premiums that will only need to be paid once.

Some bonds have a validity of one year, while others are continuous in nature.

 

Can a person still get a surety bond even with bad credit?

Yes! Back in the day, surety bonds were not issued to persons with bad credit because of the risks. But nowadays, it is very much possible to get a bond with bad credit.

Keep in mind that not all sureties accept those who have bad credit. Surety Bond Authority has a bonding program that specifically help those who have less than acceptable credit scores. Their aim is to give every person a chance to fulfill their dreams – whether starting a business or getting a license.

Those with bad credit will go through the same prequalification process. The underwriter will assess the bond premium amount based on the principal’s credit score, performance history, and finances.

A bond premium quote will be sent to the principal. Once the principal have paid the bond premium and have signed the indemnity agreement, the bond will be issued.

 

There are so many sureties out there, how can I pick the right one?

The first thing to do when choosing a surety is to check the surety’s legitimacy. It goes without saying that the right surety can help propel your business to success.

Not all sureties are licensed to conduct business in all 50 states. If you want to know if a surety is authorize to do business in yours, you need to contact your state’s insurance department.

Sureties check the character of a potential client. It is only fair that you should do the same, too. Some of the questions that you should seek answers for are the following:

  • Can the surety be trusted?
  • Does the surety have a good track record?
  • Is the surety part of a reputable organization?
  • Does the surety have enough financial strength to back you up?
  • Can the surety easily guide you through the necessary steps in order to obtain the bond that you need?
  • How accessible is the surety?
  • Can the surety patiently explain the terms of the bond and simplify any technical terms?
  • Is the surety helpful and polite?
  • How long has the surety been in the business?