What Are License and Permit Bonds?

License and Permit Bonds Explained

Builder working on a wood-framed house

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A license or permit bond serves as a financial guarantee that a business will comply with governmental laws and regulations. The bond protects consumers and governments from financial losses caused by a business’s unlawful practices. Anyone who has been harmed by a business’s illegal actions may seek compensation by filing a claim against the bond.

Many businesses need a license or permit from a government agency to perform certain operations, such as construction or road work. Before it can apply for a license or permit, a business may need to purchase a license or permit bond.

Definition and Examples of License and Permit Bonds

A license or permit bond is a type of surety bond, which is essentially a guarantee to a customer that work will be completed. It provides monetary restitution to a consumer or government agency for harm caused by a business that has violated a law or regulation. A business may be required to obtain a license bond before applying for a license. The bond assures the public that the business is legitimate and trustworthy. 

A permit bond, meanwhile, may be required by a municipality before work can be performed on city-owned property. If the business harms another party by committing fraud or otherwise violating the law, the surety (bond issuer) will compensate the injured party.

An example of a license bond is a contractor license bond. Many states require construction and trade contractors to purchase a contractor license bond before they apply for a contractor license. The bond ensures that the contractor’s customers will be compensated if, say, the contractor breaches the contract or performs shoddy work.

A business can buy a bond through an insurance agency or brokerage or directly from a surety. 

How License and Permit Bonds Work

A license or permit bond is a type of surety bond, a financial guarantee that involves three parties: the surety (bond issuer), the principal (bond purchaser), and the obligee (business or government entity that requires the bond). When a surety issues a bond, it guarantees that the principal will fulfill its obligations to the obligee. If the principal reneges on its promise, the surety must pay the obligee the dollar amount stated in the bond.

For example, suppose that Prestige Properties hires Classic Construction to build a 500-foot storage building on property Prestige owns. Classic collects a hefty down payment from Prestige and then begins the foundation work. Classic abandons the project after two days and refuses to return any of the down payment. Prestige Properties files a claim with Classic’s surety under the company’s contractor license bond. When it files the claim, Prestige includes a copy of the construction contract, a receipt for the down payment, and a detailed description of the work the contractor failed to complete. The surety pays Prestige the face amount of the bond and then demands reimbursement from Classic Construction.

If a surety makes a payment under a bond, the principal must reimburse the surety for the amount the latter paid to the obligee.

If you have a good credit score (650 or higher), a license or permit bond can typically cost 1% to 3% of the required bond amount. For instance, if the state requires a $35,000 bond, the premium should range between $350 and $1,050.

Types of License and Permit Bonds

There are many types of license and permit bonds. Here are some examples.

  • Auto dealer bond. Required in most states for businesses that sell autos to the public. The bond guarantees that the vehicle buyer can obtain a clear title to the vehicle.
  • Hunting and fishing license bond. Required in some states for businesses that sell hunting and fishing licenses or that provide guides for hunting and fishing trips.
  • Mortgage broker bond. Some states require mortgage brokers to purchase a bond before they can obtain a license. The bond guarantees that the broker will follow state laws when serving clients.
  • Special event permit bond. Some state and local governments require organizations to purchase a bond before they apply for a permit to hold a special event, such as a parade or race.
  • Encroachment bond. An encroachment bond may be required by a city or county government as a condition of obtaining an encroachment permit. A contractor may need an encroachment permit if work it intends to perform on private property might encroach on property owned by the government. The bond protects the government in the event the contractor damages or alters government-owned property, ensuring that funds are available to repair the property or return it to its original condition.

Key Takeaways

  • A license or permit bond guarantees consumers and government agencies that a business will follow the laws and regulations when conducting its operations.
  • A government agency may require a business to purchase a bond before applying for a license or permit.
  • If a bonded business violates the law and harms a consumer, the consumer may seek compensation by filing a claim against the bond.
  • If surety pays a claim, the bonded business must reimburse the surety for the amount of the payment.
  • A license or permit bond typically costs 1% to 3% of the bond amount.