What Happens When a Claim is Filed against a Surety Bond?

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Surety Bond Professionals is a family owned and operated bonding agency with over 30 years of experience. In this post, we’d like to share a little more information on how the bonding process works, specifically what happens when a claim is filed against a surety bond.

With access to a broad range of surety markets, our expert agents are ready to assist with all of your surety bond needs.

What Are Surety Bonds?

A surety bond is a legally binding contract among three parties—an obligee, a principal, and a surety. The obligee is the party requiring the purchase of the bond. The principal is the party required to purchase the bond. And the surety is the party that authorizes and guarantees the bond.

The obligee requires the principal to purchase the bond to protect the obligee and/or the public against financial loss stemming from the unlawful, unethical, or negligent actions of the principal. Surety bonds are used to provide such financial protection in a variety of situations.

License and permit bonds are the most common type of surety bond. They protect a government licensing authority (federal, state, or local) and the public against financial losses caused by a licensee. Purchasing a surety bond is a mandatory step in the licensing of auto dealers, mortgage brokers, sellers of alcoholic beverages, money transmitters, collection agencies, and dozens of other kinds of professionals.

What Can Trigger a Surety Bond Claim?

Every surety bond agreement is the surety’s guarantee that the principal will pay valid claims for damages. Such claims are triggered by the principal’s violation of the terms of the surety bond agreement. 

In the case of license and permit bonds, for instance, claims are typically triggered by the principal’s failure to pay taxes and fees due to the obligee or by professional malfeasance that results in financial harm to a consumer. For example:

  • An auto dealer falsifying an odometer reading
  • A debt collector pocketing funds collected from a debtor rather than turning the money over to the creditor
  • A notary public failing to confirm the identity of a person signing a power of attorney that is subsequently used to commit fraud

How Are Surety Bond Claims Validated?

Upon receipt of a claim against a surety bond, the surety will conduct an investigation aimed at determining the claim’s legitimacy and whether it should be paid. This may include reviewing court documents in the case of an appeal bond or ensuring that there has been a conviction in the case of an employee dishonesty bond. 

Upon reaching the conclusion that a claim is valid, the surety may attempt to negotiate a settlement for less than the full amount of the claim. However, if no settlement is reached, the claim must be paid.

How Are Surety Bond Claims Paid?

The surety bond agreement obligates the principal to pay valid claims, but the process is not quite as straightforward as that. In selling the surety bond to the principal, the surety is guaranteeing payment of claims and agreeing to extend the necessary credit to the principal for that purpose. 

So, unless there is a settlement or the principal makes good on the claim immediately, the surety will pay a valid claim on the principal’s behalf, essentially debiting a line of credit established when the bond was purchased. This extension of credit creates a debt that the principal is legally obligated to repay. If the principal does not reimburse the surety within a reasonable period of time, the surety has the right to initiate legal action against the principal.

How Are Surety Bond Claims Paid?

Most higher-amount bonds are subject to underwriting.  The surety’s biggest underwriting concerns is the principal’s creditworthiness, which is only natural considering that the surety could be laying out money to pay claims on the principal’s behalf and having to trust that the principal will repay that debt willingly. 

Consequently, the principal’s personal credit score is a big consideration in determining an appropriate premium rate. A principal with good credit is likely to pay a premium rate that’s in the range of one to three percent. Poor credit may make it difficult, and certainly more costly, to purchase a surety bond. 

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