Do You Need A Surety Bond?

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Has it ever tweaked your curiosity why you see on the back of some service trucks and on billboards the information the business being advertised is licensed, bonded, and insured? This seems quite prevalent in the service industries, i.e. housecleaning, chimney cleaning, lawn and snow removal operations, car dealerships, plumbing, electrical and septic systems, to name a few.

The licensing notification is generally a response to the state requiring you register with them showing you are meeting the requirements needed to provide the service you are wanting to offer. So, to a degree obtaining a license shows a certain level of competence in the area of business you are wanting to provide even though it does not guarantee that competence. Moreover, the licensing does not guarantee the business is sustainable or even legal. It seems to be more of a way to regulate commerce activities in the state and to collect additional revenues. If a business does not comply with licensing requirements, the license can be withdrawn, thereby halting business activities within the state.

Though it is not required, it is a wise move on the part of a business to have, before opening its doors to business, all legal agreements, insurance requirements and financial instruments in place.  When approaching a potential client, it shows good business practices to be able to point out the fact you already have in place business related legal and financial instruments. 

For the purpose of this article, let’s deal with just the question of bonding needs.

What is a bond?

It is an instrument protecting someone else promising to make payment against a loss. If you do some work which fails or in some other way fail to meet certain obligations of a contract, the issuer of the bond steps in to make payment for the loss and then turns to you for reimbursement for such payment. The obligee (entity requiring bond) knows the contract entered into will be fulfilled and can move forward with confidence in the business transaction. 

Since a bonding company in the event of a loss needs to be reimbursed, having the bond beforehand will determine your ability to reimburse for the loss; issuing your business a bond is more like a credit instrument rather than an insurance instrument. The bond issuer knows his ability to pay, so he wants to be sure you are financially capable of reimbursing him if a loss does occur.

Unlike applying for an insurance policy, which normally is rather a simple process of answering a few underwriting questions and paying a premium, this step of proving your credit capability may take some time. Quite often credit reports are ordered, financial statements are obtained, and stringent underwriting requirements have to be met before a bond is issued. If you are bidding on a job requiring evidence of a bond, get this handled as soon as possible. 

The bond activity is intended to affect how a business relates to its customers. It is intended to help alleviate the concern one might have in doing business with another concerning their expertise and ethics in the service or product being offered. It is also good to have procured that coverage so you are not embarrassed later when you learn you may not be eligible for a bond. 

By having a surety bond you are providing the court and potential business entity proof that business practices will be followed and that you have the resources to cover your business operations. The surety bond itself means a bond takes the place of money needing to be paid, property needing to be seized, or wages needing to be garnished. Having the bond removes the necessity of placing assets in escrow against future loss. 

By now it is apparent there are three parties involved with bonds: 1) the obligee–the party requiring the principal to be bonded; 2) the principal–the individual or business doing the work, and 3) the surety company–the party that insures the bond. Let’s take a look at how a bond works.

A large customer service center needs someone to come in to clean the building, wash the windows, keep sidewalks clear of snow and ice, maintain the lawn and shrubbery, monitor lighting, and dump the trash. They put out a public notice requesting someone bid on these required activities. Upon submitting a proposal, evidence of the bond must also be included.  

Your proposal is accepted and the business spells out exactly what they expect from you in the contract both parties sign. Keys of the building are turned over to you or your employee who will be doing the work. It is agreed that everything on top of the desks are off limits and need no attention. One of the company’s customer service departments is working on a big sales promotion which entails enormous amounts of computer animation and graphics. At the end of the day, much computer work is still to be done so the supervisor instructs programmers to leave their computers on so work can still be done through the night.

The cleaning people come in to do their work and find the computers still on which is contrary to normal business proceedings. The lead foreman determines he would be doing a great favor to the computer department so he makes the decision to turn all computers off. Unbeknownst to him, nothing has been backed up on the computers and all the day’s work is completely lost. The deadline for the sales promotion is missed and the company suffers tremendous financial loss because of it. 

With their (obligee) investigation as to what happened revealing the decision of the cleaning foreman, the cleaning company owner (principal) is notified. Knowing the foreman went beyond the scope of his responsibilities, the company owner notifies the bond company (surety) which steps in, accepts responsibility for loss, calculates the amount of loss, and reimburses the customer service business (obligee). At that point the bonding company makes arrangements with the cleaning company as to how the cleaning company will be able to make things right. More likely than not, the cleaning company will attempt to make a claim against their insurance company to reimburse them for their loss. If they can get the insurance company to pay them back, the financial obligation the company has to reimburse the bonding company can be met with proceeds from the insurance company. If the insurance company denies the claim,  the cleaning company will have to figure out another way to reimburse the bonding company. In either event, the customer service company will be able to stay in business without any interruption to service provided. 

In summary, the use of bonding is a positive practice for all concerned.

  1. It allows the obligee to enter business transaction with principal knowing the contract will be satisfied by the work of the principal or work of other competent party provided by bonding company;
  2. The principal can assure the bond issuer and obligee contractual obligations can and will be met; and 
  3. The bonding company has the ability before the loss to determine the strength of the principal to professionally meet contractual obligations and the principal’s ability to financially reimburse the bonding company in event of loss. 

The question of do you need a surety bond will be answered rather quickly when you begin negotiations for offering your services to another. You will sleep better knowing the bond is in place.

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