By Michael Weisbrot

Vice-President of JW Surety Bonds
New Hope, PA, USA

mike[at]jwsuretybonds.com

There are thousands of different surety bonds in the United States alone. One of the most common types are license bonds. Simply put, these bonds are required by the government in order to obtain a license to legally operate a business.

Often, people ask, “Why Do I Need A Surety Bond For My License?”. To fully understand why the bond is required, you must first know how a surety bond works. First you must understand the parties involved in the bond. There is the ‘obligee’, or who is requiring the bond (ie licensing department of the state). The ‘principal’, or the business/individual required to obtain the bond. Finally, there is the ’surety’, or the bonding company financially backing the bond. To review, the obligee requires a bond of the principal, who obtains it from the surety (usually the principal must deal with an appointed agency rather than directly with the surety).

Now that you know the parties involved with a surety bond, you will want to know what it does/covers exactly. In the event of a claim, the surety will make sure it is valid. If the claim is valid, the surety pays the obligee the amount of the claim up the the amount of the bond. The obligee (typically the state for license bonds), will then distribute the funds to the principal’s client(s) that were effected. Therefore, it is the principal’s clients who are truly the benficiary in the event of a claim, not the principal as with typical insurance.

Understanding the parties involved in a bond and how it works in the event of a claim is not the full picture. You should also know what you are actually paying for with a bond. Bonds are not insurance, they should be thought of as credit. The surety will turn to the principal for repayment of a claim and any legal fees.

It is currently an industry standard to have principals and their spouses personally indemnify for the bond. This worries many, as this gives the right to the surety to go after the principal’s personal assets to recoop losses from a claim. However, bonding companies will not go after the owners personally right away. After a claim is paid out the surety will send the principal (the company that purchased the bond) a bill for the amount paid out to the obigee and legal fees incurred. If the business fails to pay, the bonding company has the right to go after the owner’s personal assets.

Why would anyone want a bond if they have to pay the surety for a claim? It is quite simple, the alternative is a letter of credit posted directly to the state. In other words, you would have the full amount of assets frozen and you would be paying the bank for the guarantee. For strong accounts, a surety bond is the same rate or even less than a letter of credit. Therefore, it makes no sense to tie up capital and pay the bank a fee that often costs about the same as the bond.

To summarize, a bond is not insurance, but should be thought of as surety credit. A claim will pay out to the obligee (the state), who will distribute the funds to the principal’s client(s) that were effected by the principal’s negligence. If a claim is paid, the surety will look to the principal for repayment, per the terms of an agreement signed prior to release of the bond. The alternative is a letter of credit, which usually costs roughly the same price, but will tie up capital that could be better used. Surety Bonds have been around for quite some time now, and will be here for quite some time to come.

Michael Weisbrot is Vice-President of JW Surety Bonds, a bond only agency.

Published - December 2005