Surety Bonds: Consumer Protection

How do Surety Bonds act as the best consumer protection tool ever?


Surety Bonds as Consumer Protection

I always find it interesting that few people know the definition of a surety bond. Enclosed in this article is essential information about how a surety bond works and how they protect the consumer.

There have been countless news stories about consumer and financial fraud, with business professionals acting unethically to take advantage of others. From simple consumer misrepresentations to large-scale financial fraud like the billion-dollar Ponzi scheme involving Bernard Madoff, federal and state regulators have been finding ways to protect the consumer’s interest.

However, there is one financial instrument that has been available to consumers for a very long time that can provide sure-proof client protection. These are the surety bonds. Surety bonds are required by most states for some sectors, including construction, mortgage, automobile, transportation, real estate, financial transactions, and many others. Surety bonds are aimed at providing guarantees that businesses will fulfill their contractual obligations or face penalties. More importantly, the various types of surety bonds are legally binding documents that many companies and even industries, cannot operate without obtaining the necessary surety bond.

Although surety bonds provide protection, it should never be mistaken for an insurance policy. An Insurance Policy is a two-way party contract that protects the business or the person. Surety Bonds are three-way party contracts that are meant to protect the public/customer.

The Difference Between a Surety Bond and Insurance Policy

There are three parties involved in surety bonds under contract. The Obligee is the party being protected by the surety bond. The Principal is the party required to obtain the bond and perform its contractual obligations while the Surety Company guarantees to the Obligee that the Principal is competent and will perform the task.

Traditional insurance policies compel the insured to pay an ongoing premium for continued coverage, but surety bonds work part insurance and part credit. To be more precise, the surety bonds offer protection for the Obligee, and these are backed and paid for by the Principal. Sureties always sit in the middle by giving a guarantee that an aggrieved party will be compensated and reimbursed for the payment from the other party if a claim against the surety bond is made.  In essence, surety bonds extend a temporary line of credit for the Principal and the Surety who issues the surety bond is simply saying, “I trust you, Mr. Principal, to complete the contract for the Obligee.”

Because an insurance policy is a two-way contract, it is an agreement between an insurance company and an individual or entity who wants to purchase financial protection against any losses by transferring some of the risks to the insurance companies. The insured party is expected to receive reimbursement from the insurance company by filing a claim against the insurance policy against any losses.

How Surety Bonds Protects Consumers?

Imagine buying a car or a laptop, but when you take the items home, you find that they are lemons. The car breaks down, or the laptop won’t boot. Or you noticed that the car dealer had not disclosed important information about the automobile that they are required by law or the laptop has missing software that should have been pre-installed as stated in the specs of the unit.

This is where surety bonds can offer you the consumer protection that you need. By law, you can file a claim.  Even if the dealers refused to pay or declare bankruptcy, the surety firm will still pay you. The surety will then go after the dealers to be reimbursed.

But the most vital consumer protection given by surety bonds is in the construction industry. Since the passage of the Heard Act in 1894, all federally-funded public projects are required to be accompanied by surety bonds to protect taxpayers' money used to fund those projects. The Heard Act spawned other trade regulations in other industries that now require surety bonds with the primary purpose of protecting consumer rights.

The bonds obligate contractors that they would perform their jobs as specified in the contract within the stated time frame. Contractors also benefit when posting bonds for their projects because it allows them to free their assets from being tied up to guarantee the performance of their contractual obligations. This allows contractors to accept multiple jobs instead of focusing on one project at a time.

Surety bonds guarantee customers of timely payment and force the contractor to get a job back on track in case of inadequate performance or should the contractor renege on its obligations. But contractors can also ask their clients to post another type of bond, this time to guarantee the customer’s payment to the project.

Some surety bonds authorize the bonding company to intervene if the contractor is failing in his or her contractual obligations or has abandoned a project. The surety can either find a replacement or give financial assistance to the contractor to enable them to finish the project or reimburse the client.


Surety Bonds Boost Business Reputation

At first glance, surety bonds could be perceived as a business burden because of the often strict procedure when obtaining one. However, looking at it from a bigger perspective, they benefit business owners too because surety bonds help improve the overall image and reputation of a particular industry.

In an industry wherein regulators require surety bonds; customers are given an assurance that the industry will protect their interest and the business is obliged under law to avoid unethical practice until their business is closed down.

And while it is not mandatory under current regulatory requirements, an enterprise that allows any of its employees access to valuable assets, cash, or important documents, can be amply protected by posting a fidelity bond.  A Fidelity Bond acts like insurance to the business in case an employee steals from the company or should a valuable asset be damaged or lost. The business owner can file a claim against the fidelity bond for reimbursement. Financial institutions and professional cleaning firms are often required to obtain fidelity bonds to protect from employee theft.

Other Benefits of Surety Bonds

For the consumers:

  • Guarantees fulfillment of the contractual obligations, including materials, workmanship, quality of work, and costs to timeliness
  • Encourages contractors to finish the project as specified in the given timeframe; contractors are given time to make adjustments in case the project is not finished according to the agreed standard or is completed beyond the timeframe
  • Guarantees quality of work and standard, including materials used
  • Ensure quality performance and timeliness of the delivery of the finished project; make sure that the contractor complete the project on time, and reimburse the client if they incurred any losses as a result of the delay
  • Protect against losses, including lost deposit arising from the contractor’s delay or repair costs


For the business owners/contractors:
  • Boost business reputation and improves image to clients; clients appreciate surety bonds because they provide financial and contractual guarantees that the project will be completed as specified in the contract
  • Surety Bonds increases the likelihood that the contractor will win the bid; it shows the contractor’s ability to deliver on its commitments, and this is backed by a bond
  • Assures subcontractors that you as a contractor are committed to the project and will see to its completion and is ready to work with them. The surety bonds also build confidence in your subcontractors that they will bet paid
  • They are required by law, particularly when involving publicly-funded projects, as well as a requirement before a contract is awarded. A contractor’s ability to obtain a bond quickly allows them to take on large-scale projects


Consumer Awareness is Still Lacking

However, despite the many benefits of surety bonds to the consumers, there is little public awareness about them. It is important for consumers to know their rights and how to protect themselves against fraud or unethical practices. Understanding how surety bonds protect your consumer rights is vital in our day-to-day transactions. Businesses should also do their part in educating the public about their bonded status. The surety bonds benefit their business as well. Everybody wins.

Surety bonding is a significant tool that benefits both the consumers and the business owners, but you have to choose the appropriate bond that you need. There are generally three sub-categories of Commercial Surety Bonds. They are: License and Permit Bonds – these are required by state or regulatory agencies before a business is issued a license or permit.  Court bonds – these are court-related bonds, including bail bonds, civil bonds, and fiduciary bonds.  Public official bonds – these are posted by elected and appointed public officials, including law enforcement officers and treasury officials to guarantee that these officials will perform their duties faithfully and honestly. All the other bonds that do not fall into the above categories are categorized as “miscellaneous” commercial surety bonds.


Cost of Surety Bonds

Depending on the type of surety bond that you need, the cost of bonds varies. Your location, credit score, and other factors also influence the cost of bonds. Some bonds are quite expensive, and some are cheap. Each underwriter sets their own specific cost structure so be sure to work with a reputable surety or agent if you require one. In general terms, surety bonds are computed between 1% and 15% of the total value of the bond. But industries that have a higher risk than others, like construction, financial institutions, etc., are required to post bonds that cost up to 10% or above of the bond’s value.

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"Surety Bonds: Consumer Protection"

Surety Bonds as Consumer Protection
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2 Responses

  1. John

    After reading this article, I can see why surety bonds can offer good consumer protection. I liked the section of the article that talked about how if a dealer sells you a defective car or laptop, a surety bond protects the customer since the surety firm will pay you to compensate you for your malfunctioning equipment. I also thought it was good to know that surety bonds can help in building projects. My friend is looking to start his own sports medicine clinic, so i’ll be sure to check if he has looked into surety bonds for the building process so that everything gets done in a timely manner.