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Bonding for
Businesses
What is Bonding? "Bonding is surety, the state of
being sure, certain and secure". Surety bonding is
essentially an agreement between three parties whereby
one party guarantees that another party will perform the
work that is stated in contract to the best of his/her
ability. It is a guarantee that the owner of a job will
receive the quality and completion of work that he/she
anticipates.
Depending on what type of business you are in, you may
be required (by law) to obtain bonding before you can
start work. For those of you who are not required to
seek bonding, you may decide that the benefits of
obtaining it are well worth the hassle. Whatever your
case, there are many different kinds of bonds to choose
from and each of them serves a different purpose.
The three most common types of bonds are:
Contract Bonds/Bid Bonds: Most often used in the
construction industry, bid bonds ensure owners that the
contractor who is the lowest bidder on their job, can
and will enter into contract at the tendered price. If
the contractor fails to fulfill his/her obligations
under the bid bond, he/she must compensate the owner for
the difference between his/her bid and that of the next
lowest bidder.
When applying for a bid bond, surety companies look at
much the same characteristics in an applicant as a bank
does when issuing a loan. First, the surety will conduct
a review of the company's management performance. This
will give the surety knowledge of the company's history,
as well as provide information on whether or not the
company is respected in the construction community.
Next, the surety will examine the qualifications and
background experience of the contractor’s personnel.
Finally, the tangible net worth of the contractor will
be determined through financial statements and the net
worth of its shareholders. This will help the surety
determine whether or not the contractor will have the
financial capacity to complete the project.
In addition to the basic criteria, when qualifying for a
bond, surety companies also examine contract-related
characteristics. These may include: The Nature of the
Work, does the project fall into the contractor's range
of expertise; Project Location, is there more risk
involved because of the project's distance or remote
location; Completion Date, will the long duration of the
project create greater risk of incompletion; Legal
Conditions, are there any legal clauses stating what
will happen under unusual situations; Communication,
does the contractor exhibit good management skills
including the ability to make accurate cost projections?
There are several reasons why a contractor should
apply for bid bonds. First, bid bonds assure the
business owner that the contractor is acting in good
faith. Secondly, it guarantees the business owner that
those who are bidding on his/her work have the financial
and technical knowledge to complete the work. Finally,
bid bonding reduces the demand that is placed on a
contractor's assets and bank credit.
Since most surety companies use the applicant's work
experience to determine whether or not he/she will
qualify for bonding, it is not uncommon for new
businesses to be denied. If you find your business in
this situation, do not be discouraged. There are many
smaller contracting jobs that do not require bonding. As
you complete more jobs and prove your company's
viability, you will build a name for yourself in the
industry and will qualify for bonding soon enough.
Fidelity Bonds
Fidelity bonds insure a business owner financial
coverage for losses caused by a dishonest employee.
Under fidelity bonding the owner is covered up to the
amount of the bond. The surety company will then seek
reimbursement from the employee.
There are several different types of fidelity bonds.
Named Schedule Fidelity Bond - this type of bond
provides coverage over the employee(s) that are named on
the bond. Coverage is available only when the employer's
loss can be directly traced to the individual. There is
no coverage for mysterious disappearance.
Blanket Position Bond - under a blanket position
bond the employer has coverage over all of his/her
employees. The bond automatically covers new employees
and ceases the coverage of prior employees upon
resignation or termination. The Blanket Position Bond
will cover each employee involved in an incident up to
the coverage amount. For example, if you as an employer
caught 10 dishonest employees and the bond amount was
$10,000, you would be eligible for $100,000 in coverage.
Unlike Named Schedule Bonds, under a Blanket Position
Bond the employer does not have to prove which employee
was responsible for the loss.
Primary Commercial Blanket Bond - this type of
bond is similar to the Blanket Position Bond except that
the amount of the coverage is usually smaller. Where the
Blanket Position Bond will cover each employee up to the
bond amount, the Primary Commercial Bond will pay out
the same amount regardless of how many employees are
involved. For example, if there are 10 employees
involved in a loss and the bond amount is for $50,000,
the employer is eligible for $50,000. If there is only
one employee involved however, the employer would still
be eligible for $50,000.
Miscellaneous Bonds
There are many types of bonds that have no category of
their own. Though they fall under the broad heading of
miscellaneous, surety companies still have to be sure
that the applicants are fully qualified to perform the
obligations of their contracts. Before issuing any of
these types of bonds, the surety must know the
applicant's education, training, and related work
experience. Financial information from the most recent
fiscal year must also be provided.
Some of the most common Miscellaneous Bonds are:
License and Permit Bonds - certain industries
lend themselves to areas where licenses and permits are
required. Usually required by service firms, these bonds
make the business owner financially responsible for any
injury or damage caused to the public. Service firms who
may require these type of bonds include electricians,
gas stations, used car dealers, and real estate agents.
Customs and Excise Bonds - these bonds ensure the
federal government that taxes and duties will be paid by
the bond applicant upon request. This type of bond
allows applicants to run warehouses and import goods
duty free. They also ensure that the operators will pay
the federal government all required taxes. For example,
under custom and excise, cigarette and alcohol
manufacturers must make sure that their retailers are
collecting taxes for their goods and that they are being
received by government. The Customs Bonded Warehouses
Regulations specify the requirements for the licensing
and operation of a bonded warehouse. Contact Canada
Revenue Agency at 1-800-461-9999 for further information
on this type of bond.
Court Bonds - this type of bond is required for
litigation cases in the courts and is needed when a
plaintiff claims that the property of the defendant is
rightfully his. If the plaintiff is correct, he/she will
gain custody of the property. However, if it is found
that the plaintiff is not the true owner of the
property, he or she must return the property or pays its
value plus damages to the true owner.
Performance Bonds - performance bonds guarantee
the performance of the contracted work. If the owner of
a job is not satisfied with the contractors work or
feels that the contractor did not perform the level of
work that was specified in the contract, he/she can look
to the issuer of the bond for compensation.
The surety prequalification process is very thorough. It
is important to choose a professional surety producer
you are comfortable with to guide you through this
process.
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