What surety bonds covers

Every bond names three parties. The principal is the person or business whose performance is being promised: the contractor, the dealer, the executor. The obligee is the party the promise is made to and the only one who can claim on the bond: the state licensing board, the project owner, the court. The surety is the company that issues the bond and pays a valid claim. Insurance protects the person who buys it; a bond protects the obligee, and the person who buys it remains fully liable to the surety for whatever it pays. That is the whole difference, and every other feature of a bond follows from it.

State contractor licensing boards require a license bond before a contractor can hold a licence in the classification they work in. The bond guarantees that the contractor will comply with the licensing law and the board's rules, and it gives a homeowner or a supplier who is harmed by a violation, such as abandoning a job, taking a deposit and not performing, or failing to pay for materials, a way to recover up to the bond amount. Each board sets the bond amount and the form by classification and by whether the contractor works residential or commercial, and publishes the current figures; the bond has to be filed with the board on its form and kept continuous, because a lapse suspends the licence.

A claim against a license bond is paid by the surety to the claimant and then collected from the contractor with the surety's costs. A paid claim also makes the next bond harder and more expensive to obtain, so a dispute with a customer is worth resolving before it reaches the board.

Public agencies, and increasingly private owners and general contractors, require contract bonds on construction work. A bid bond guarantees that the low bidder will sign the contract and provide the further bonds if awarded the job. A performance bond guarantees that the contractor will complete the work according to the contract; if the contractor defaults, the surety finishes the job, pays for another contractor to finish it, or pays the owner the cost of completion up to the bond amount. A payment bond guarantees that subcontractors and suppliers will be paid, which is why they cannot lien public property. These bonds are underwritten on the contractor's financial statements, work in progress, bank line and history, and a surety's capacity for a contractor is expressed as a limit per job and in total.

Beyond contractors, many regulators require a bond as a condition of a licence or permit: a motor vehicle dealer bond, a mortgage broker bond, a notary bond, a freight broker bond, a bond for a business that collects sales tax or sells alcohol, a right-of-way permit bond for work in a city street. Each is written on the regulator's own form with its own amount, and most are renewed annually or for a multi-year term. Court bonds are required when someone asks a judge for a remedy that could harm the other side, such as an injunction or an appeal, and fiduciary bonds when a person is appointed to manage someone else's money as an executor, administrator, guardian or trustee; these guarantee faithful performance and are sized to the estate.

Before a surety issues a bond it has the principal, and usually the owners personally and their spouses, sign a general indemnity agreement. It obliges them to reimburse the surety for any amount paid on the bond plus its investigation and legal costs, and it allows the surety to settle a claim it judges valid. On a claim, the surety investigates whether the principal failed the obligation; if it did, the surety pays the obligee and pursues the indemnitors. If the principal has a defence, the surety raises it. Understanding that a bond is a credit instrument with personal recourse is the point most applicants miss when they compare its premium to an insurance premium.