Believe it or not, surety bond contracts have been used to guarantee work performance for thousands of years, and various government agencies in Tennessee have used surety bonds to regulate an array of industries for decades. But don’t worry; you’re not alone if you’re wondering what exactly surety bonds are. Even though surety bonds are used throughout countless industries in Tennessee, many business owners and other professionals who live and work in Tennessee know little of these risk mitigation tools until they find out they need one. Many assume surety bonds work like other types of insurance, but this is not the case. To help eliminate some of the mystery surrounding surety bonds, this guide will outline some crucial aspects of bonding — from how they work to how to get them.
Surety Bond Basics
Before discussing specific Tennessee surety bond protection, let’s review A basic definition explains that a surety bond is a legally binding contract used to guarantee a certain task is completed adequately. Each surety bond contract involves three parties.
- The principal purchases the surety bond as a financial guarantee of work performance or task fulfillment. Business owners or other individuals preparing to take on a significant amount of responsibility typically act as the principal.
- The obligee requires the principal to purchase a surety bond. Government agencies typically act as obligees that require bonds to reinforce industry regulations while also limiting the possibility for financial loss.
- The surety is the insurance company that backs the bond. If the principal fails to uphold the bond’s terms and a valid claim is made, the surety will be responsible for reimbursing the claimant up to the bond’s full amount.
Although underwritten by insurance companies, the financial protection provided by surety bonds functions more like a line of credit than an insurance policy. If an insurance company is forced to pay out on a claim made against a bond, it will not simply absorb the loss. Most bond forms include an indemnification clause that requires the principal to repay the insurance company. So even though the financial guarantee protects consumers as do insurance policies, the financial accountability is distributed differently.
Surety Bond Types
Surety bonds can be broken down into three main categories that can be further broken down into subcategories. Tens of thousands of individual surety bond types exist, but reviewing the major groups allows for a general understanding of bond protection.
- Contract bonds guarantee projects are completed according to contractual terms. These bonds are most frequently used in the construction industry as a way to keep those involved in projects from losing their investments.
- Bid bonds keep contractors from increasing their bids after a contract has been awarded.
- Performance bonds require contractors to complete projects at a certain standard.
- Payment bonds ensure contractors pay their subcontractors and material suppliers appropriately.
- Commercial bonds generally reinforce industry regulations. Most commercial bond types are license and permit bonds, which, as their name suggests, are before they can receive a license and/or permit. Common commercial bonds required in Tennessee include motor vehicle dealer bonds, contractor license bonds, notary bonds and mortgage professional bonds, among many others.
- Court bonds uphold the integrity of the legal system. You’ve likely heard of bail bonds that require those facing charges show up to their court dates. Guardianship bonds ensure legal guardians appropriately manage the finances of those they’re responsible for.
Surety Bond Costs
The premium principals pay to get bonded varies due to a number of factors.
- Bond amount. Generally speaking, the higher the bond amount, the higher the cost. Some states require auto dealers to purchase a $10,000 bond while others require a $50,000 bond. Auto dealers who need a $50,000 bond will obviously pay more for their bond than those who need one for $10,000.
- Bond term. Some bonds are issued for just one year while others are issued for multiple years. Purchasing a janitorial bond for three-year term will cost more than doing so for a one-year term.
- Applicant’s Financial Credentials. Because insurance companies have to pay out claims on bonds from time to time, surety contracts include indemnity agreements that require the bonded principal to reimburse the surety for any claims paid. To verify that applicant has the financial capacity to do so, some bond applications require a financial review. For this reason, applicants’ credit scores can directly affect their bond premiums.Surety bonds are issued with the understanding that claims will not be made, which is why they can be difficult for some applicants to qualify for. Some surety bond types — such as telemarketing bonds, credit service company bonds and contract bonds — can be nearly impossible to get for those who have bad credit. Due to past claim and loss history, these bonds are risky to issue to applicants who have bad credit. Fortunately, a few surety providers do have bad credit bonding programs to help applicants with credit issues get the bonds they need.
Surety Bond Applications
To begin the process, applicants should contact a surety bond company that’s legally licensed to issue surety bonds in Tennessee. Most surety providers accept applications via fax, phone or e-mail. After submitting an application, applicants receive a price quote for their bonds. Surety specialists typically begin issuing bonds as soon as payment is received. After the principal receives the bond, it will need to be filed appropriately with whatever government agency — or other obligee — required it. Before principals file their bonds, they must ensure all information on the form is 100% accurate. For example, government agencies frequently refuse to accept bonds that feature a business name that’s not the same as on the business license. Even the smallest typo can invalidate the bond, so checking for accuracy is a crucial aspect of the bonding process.Surety bonds can be confusing, but with a basic understanding of how they work and why they’re required, principals can better prepare themselves for the bonding process whenever the need arises.
Source: Danielle Rodabaugh, Chief Editor of the blog at Surety Bonds a nationwide surety insurance company.The material in this publication is based on work supported by the U.S. Small Business Administration under cooperative agreement SBAHG-04-S-0001. Any opinions, findings and conclusions or recommendations expressed in this publication are those of the author and do not necessarily reflect the views of the U.S. Small Business Administration. The information contained in this publication is believed to be accurate and authoritative but is not intended to be relied on as legal, accounting, tax or other professional advice. You should consult with a qualified professional advisor to discuss issues unique to your business. Copyright 1990. SBA retains an irrevocable, worldwide, nonexclusive, royalty-free, unlimited license to use this copyrighted material.