What Are Commercial Bonds and Why Would I Need One?
Many times a client will come to me questioning why someone is requiring them to have a commercial bond. This article will provide some information to help explain what commercial bonds actually are, who they are protecting, and what types of commercial bonds are most commonly written.
Bonds function much like insurance in that they guarantee that obligations are fulfilled. If a promise is breached, the bond will pay to fulfill the promise. There are generally 3 parties: The bond holder (principal), the party for whom the work is being done (obligee), and the company providing the bond (surety company).
The two most common bond types are Surety Bonds and Fidelity Bonds. The basic difference is that a surety bond protects the public. A fidelity bond is employee dishonesty insurance coverage. In a nutshell, if someone is requiring you to provide a bond, you are looking for a surety bond. If no one is requiring the bond, you are more than likely looking for a fidelity bond.
You may be wondering, “When do I need to purchase a surety bond?” A surety bond should be purchased if a party is trying to protect their interest in a job they have awarded to you. If you are a contractor, for example, you may be required to provide a surety bond to guarantee your performance. However, if you fail to complete the contract, the bond will step in to pay another contractor to finish the job. However, that doesn’t mean that the bond pays and you are free and clear.
Here is an example: You are a paving contractor hired to repave the parking lot at the local municipal building. They require that you provide a bond for the amount of the contract that you are awarded. You walk off the job before the job is completed. The municipality (obligee) will file a claim with the surety company and the surety company will hire another contractor to finish the project. The surety company then will come back to the bond principal (you) for reimbursement along with any additional costs they incur to get the job completed.
The most common type of bonds I write are contractor licensing bonds. These are required by cities, counties, or other local government entities in order for a contractor to pull a permit to conduct work within the jurisdiction. The government entity is requiring this bond (usually $5k or $10K) to guarantee that the contractor will comply with the applicable laws and regulations. They can also guarantee indemnity to third parties who sustain injury or damage as the result of the contractor’s activities that are described in the license or permit. For example, a sign business that hangs signs over public sidewalks may be required to provide a bond to guarantee compensation for injuries to pedestrians.
While surety bonds may be what you are most familiar with, the other common type is a fidelity bond. This type of bond protects the holder against theft, embezzlement, or employee misconduct that is not otherwise covered under regular insurance. One common example is an ERISA bond for pension plans. If your business has a defined pension plan, you are required by tax law to have a bond that is equal to at least 10% of the assets. This protects against dishonesty by those handling the company’s pension plan.
Another example of the need for a fidelity bond is for service businesses. If a business has employees working on a customer’s premises, a fidelity bond will provide coverage for the employees’ fraudulent or dishonest acts. Often you will see a company advertising “licensed and bonded”; that means they are guaranteeing against any acts of wrongdoing by their employees while they are completing a job.
For example: You own a cleaning company and an employee steals jewelry from a home they are sent to clean. The surety company would reimburse the customer for the jewelry. This would not be covered under a standard general liability policy because intentional acts are typically excluded.
How much do commercial bonds cost?
There are no set rates for commercial bonds as there are many factors that can impact the cost, such as the type of bond, the amount of coverage, and the surety company that issues the bond. The common licensing bonds start at around $100, where as a performance bond can generally around 2% of the project cost (or in some cases more), or about $20,000 for a $1M contract. As with all insurance, bonds are written and reviewed on a case by case basis. For some bonds such as agricultural bonds, auto dealer bonds, large contract bonds (just to name a few), you may be asked to provide financial and tax statements for both the LLC and corporation, in addition to the personal financial information for all owners and officers of the organization.
The explanations and examples given here are for the most common types of bonds and occurrences. There are many other types of bonds and situations. Our office will be more than happy to assist you if you have a situation for which a bond is required. We will need just a few simple things to get started: 1) Who is requiring/requesting the bond? 2) What will you be doing? 3) What coverage does the person requesting the bond hope to achieve? Once we receive this information, we will be able to being the process of finding a product that will best suit your needs.