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Overview
Surety bonds are used by businesses and government agencies to ensure another party fulfills contractual obligations. Developers and other individuals and organizations commonly require surety bonds from construction companies and independent contractors. Surety bonds are also used when a party is responsible for handling significant amounts of money as a business function or in a position of public trust (such as the executor of an estate), or to assure compliance with the law.
Identification
Surety bonds are a three-way contract that protects one party (the obligee) against losses resulting from another party (the principal) failing to meet contractual or legal obligations. The third party (the surety) guarantees to pay the losses on behalf of the principal. When a business or individual obtains a surety bond, they pay a fee that is a percentage of the amount of the bond. In the event a principal defaults on the obligation, the surety pays the bond and assumes the status of a lender and has the right to recover the loss from the principal if possible.
Types
There are many kinds of surety bonds. Contract bonds are used to insure against failure to complete a project, especially in the construction industry. License or permit bonds are required by state and local governments to assure compliance with regulations. In some cases, appointed or elected officials (including executors) need public trust bonds. Bail bonds are required by courts to guarantee an accused person shows up at hearings and trial.
Requirements
Surety bonds are provided by insurance companies, underwriters and specialized surety firms. When a business or individual needs a surety bond, they must meet criteria similar to those for making a loan. The surety provider will want financial statements, documentation of net worth and evidence of good credit (typically a credit score of 670 or higher). When the surety bond is for a business project, the principal must show he has the resources and expertise to complete the project and a clear plan for doing so.
Costs
The cost of a surety bond can vary widely. It's based on the size of the bond and the risk the principal poses. As a general rule of thumb, surety bond providers want the principal to have a net worth at least 5 times the value of the bond. Depending on the past performance, credit history and risk of the project, the bond may cost from 1/2 percent to 3 percent of the bond amount. For example, a $50,000 surety bond would cost $250-$1,500. Persons or organizations who fail to qualify with an insurance company or other provider can sometimes turn to high-risk specialists but pay 5 percent or more of the bond value.
Bail Bonds
Bail bonds have some special characteristics, due to the circumstances under which they are issued. The size of a bail bond is set by a court, based on risk of flight or to public safety. The default rate is high, and consequently bail bondsmen charge fees of 10 percent or more of the bond. In the event of default, they have limited legal authority to track down and apprehend a person who has "skipped bail," as well as the right to attempt to recover any losses.
