License and Permit Bond

• One of the most common types of surety bonds is a license and permit bond. When a commercial enterprise, such as an automotive dealer, wishes to operate within a state, it must first obtain a bond guaranteeing the state that it will operate according to the terms stated in the license. In order to do business, the company (principal) first obtains a surety bond from an approved bonding company (surety or carrier) and delivers it to the state's regulatory authority (obligee). In forming the surety bond, the bonding company makes a written guarantee to the state that the company will operate according to terms. If the company breaches state regulations, the obligee may legally claim compensation from the surety.
  
  

Claims And Compensation

• If the surety has to compensate for a claim placed by the obligee, it attempts to recover the funds from the principal, including all costs associated with processing the claim and any legal fees. This is the major difference between insurance and surety bonds. If the contract was an insurance policy and not a surety bond, the bonding company would not be able to legally pursue the principal for recovery of payments made on the claim. The surety is able to pursue the principal because prior to forming the surety bond, it requires the principal to sign an agreement stating that the principal will be held solely responsible if a claim is made.
  
  

Comparison With ILOC

• A common confusion regarding surety bonds is the necessity of the arrangement, given that the principal ultimately has to pay for the claim. It is important to understand that suretyship is not insurance, but a form of credit. Surety bonds are formed because the contract requires no collateral for the formation of a bond, whereas its only other alternative, the irrevocable letter of credit (ILOC), requires a 100-percent collateral. Even though surety bonds may have a higher interest rate than ILOC, the provision of no required collateral means that the principal can form the bond without having to pay a substantial amount initially.
  
  

Contract Bonds

• The main types of surety bonds are contract bonds and commercial bonds. A contract bond is formed to guarantee the terms included in a specific contract. The surety is not required to make payments if the obligee's claims fall outside the obligations expressly stated in a contract bond. Common types of contract bonds include performance bonds, bid bonds, maintenance bonds and payment bonds.
  
  

Commercial Bonds

• Commercial bonds, also referred to as noncontract bonds, do not involve specific contracts. Commercial bonds have numerous subcategories, and each category in turn contains different types of bonds. Commercial bonds may be required by state or regulatory bodies when an enterprise wishes to obtain a license or permit to legally operate in a particular industry within the region. Common types are contractor license bonds, mortgage broker bonds and motor vehicle dealer (MVD) bonds.