What are surety bonds?
Surety bonds are financial guarantees typically issued by insurance companies to protect one party from financial loss if another party fails to fulfill contractual obligations or comply with applicable laws or regulations. Although surety bonds may seem unfamiliar, they play an important role for contractors, business owners, court-appointed fiduciaries, and individuals who need financial protection.
The Miller Act is a federal law that requires contractors on federally funded construction projects (typically those over $100,000) to obtain performance and payment bonds. The Little Miller Act refers to state-level versions of the federal Miller Act that apply to state and local public works projects. Each state has its own Little Miller Act with similar requirements adapted to state law, requiring performance and payment bonds on state and local government construction projects.
Surety bonds protect people in three ways: they make sure businesses follow the law and regulations, they protect customers and creditors from losing money if a business fails to do what it promised, and they prove that a business is trustworthy and financially responsible.
Every surety bond involves three parties: the principal (i.e., the individual or business required to obtain the bond), the obligee (i.e., the government agency or party being protected), and the surety (i.e., the bonding company that guarantees performance and pays claims if the principal fails to meet their obligations).
Surety bonds work by having the principal pay a premium to the surety company for the bond, after which the surety agrees to pay the obligee a claim (up to the bond limit) if the principal fails to meet their obligations. If the surety does pay a claim, the principal is then required to reimburse the surety for that payment.
Commercial surety bonds and contract bonds are both types of surety bonds that protect against financial loss, but they serve different purposes. Commercial surety bonds are typically required by government agencies or courts to ensure regulatory compliance and protect the public from business misconduct or breach of duty. Contract bonds, on the other hand, are specifically tied to construction or service projects and guarantee that a contractor will complete the work as contracted and pay suppliers and laborers. While commercial surety bonds provide ongoing protection for regulatory compliance, contract bonds are project-specific guarantees that the work will be completed on time and within budget.
The most common commercial surety bonds include license and permit bonds, which are required by government agencies across industries like agriculture, healthcare, real estate, and retail to ensure regulatory compliance. Court and fiduciary bonds are also widely used to guarantee that executors, administrators, guardians, and trustees will properly manage assets and fulfill their duties. Notary public bonds are required in nearly all states for notaries to ensure they perform their duties faithfully and comply with state laws. Additionally, workers compensation bonds are common for businesses approved as self-insurers to guarantee they will pay workers compensation claims as required, and public official bonds ensure that government officials and public employees perform their duties honestly and protect public funds.
The most common contract bonds include performance bonds, which guarantee that a contractor will complete a construction or service project according to contract specifications, timeline, and budget. Payment bonds guarantee that a contractor will pay suppliers, subcontractors, and laborers for materials and services provided on the project. Bid bonds guarantee that a contractor who submits a bid will enter into a contract if their bid is accepted and will obtain the required performance and payment bonds. Maintenance or warranty bonds guarantee that a contractor will repair or correct any defects in workmanship or materials during a specified warranty period after project completion.
Fidelity bonds protect against employee dishonesty and fraud by guaranteeing coverage for theft, embezzlement, and misconduct. ERISA bonds are a specific type of fidelity bond required under the Employee Retirement Income Security Act that protect employee benefit plan assets from theft, fraud, or dishonest conduct by plan fiduciaries and employees. These bonds ensure that individuals managing retirement plans, health insurance plans, and other employee benefits act honestly and in the best interest of plan participants. Business services bonds, while broader in scope, also provide protection for customers and clients by guaranteeing that service providers will perform their contracted services honestly and in compliance with applicable laws, protecting against fraud or misappropriation of client funds.
The cost of a surety bond, known as the premium, depends on several key factors including your personal and business creditworthiness, business history and financial stability, and the type and amount of bond coverage needed. The industry risk, years in business, and your experience in your industry also affect the premium rate, as do the size and profitability of your business. Surety companies assess these factors to determine the level of risk involved in issuing the bond, with stronger credit, longer business histories, and higher profitability typically resulting in lower premiums.