Basics

• The customer requiring a surety bond is called the obligee. The contractor who pays the surety bond premium is called the principal and agrees to indemnify the surety or pay damages involving the bond. A contractor hoping to post a bond can go to his insurance broker, who probably already has his financial information. If a contractor does not meet the terms of the surety bond, the customer can file a claim, and the surety can seek money from the contractor to pay the claim plus legal fees if it decides the claim is valid.
  
  

Advantages

• A contractor may wonder why she should pay a surety bond premium if she has to pay claims, but surety bonds are not insurance. They are a guarantee. The contractor could post cash or get a letter of credit from her bank that guarantees the bank will cover the contractor's liabilities. Surety bonds, however, which are a less expensive alternative, can free capital. In addition to entailing a fee, a letter of credit requires the contractor to pledge assets to the bank, and the bank could shrink the contractor's line of credit, which could curtail the contractor's cash flow.
  
  

Obtainment

• A contractor seeking a surety bond should obtain a blank copy of the bond from the customer and give it to the bond agency, which will use it to provide the bond. The time needed to approve a bond varies from one to four business days, although some are approved immediately. The surety investigates the contractor's character, construction experience and financial strength to make sure the contractor can finish the project to the customer's specifications and pay any claims. The surety also wants to see experienced personnel in the contractor company's top management posts and a contingency plan in case managers leave during the job.
  
  

Costs

• Costs for bond premiums vary, depending on the type of bond, the obligee and the contractor. Premiums typically range from 1 to 3 percent of the bond amount, but bonds involving higher risks can have premiums of 5 to 20 percent. Besides seeking the lowest premium, a contractor may consider obtaining a larger bond that could qualify him to do more work, as well as the surety's experience and financial strength and how it might work with the contractor if problems with the job arise.