What Is A Surety bond?
A surety bond is a contractual agreement that involves three parties, namely the principal, the surety, and the obligee. It is a risk management plan primarily designed to ensure commitment towards an agreement in business practices. If you are a contractor, you may not be able to bid for or get some contracts without a surety bond. Also, as a business owner, a surety bond will be required in some legal claims and to obtain certain licenses.
Understanding the Three Parties In a Surety Bond Agreement
- The Principal
The principal is the entity (business or individual) in need of a surety bond as a form of guarantee for future work performance. A surety bond is used for different purposes, such as getting a business license, completing a court case, guaranteeing business protection, or completing a contract. If there are damages or a breach of contract on the part of the principal, the claims will be settled by the company that issued the bond.
- The Obligee
The obligee of a surety bond is usually a legal entity, such as government agencies. It is the entity that requires a surety bond from a business outfit before offering them a contract. This is in line with the Miller Act passed in 1935, which helps protect the public interest from local contractors. The surety bond will help reduce the likelihood of financial loss and ensure commitments to contractual agreement from the principal.
- The Surety
The surety is a risk management company (usually an insurance carrier or a bank) that is responsible for the bond payment if there is a damage caused by the principal. If the obligee files acclaim for damages, the surety will initially cover the cost. With that, the interests of both the principal and the obligee will be timely protected. Although, the full cost of the damages will still be fully paid back by the principal, but at a later date.
How Does a Surety Bond Works?
There are thousands of bonds in the US regulated by each state government. Amounts and requirements are dependent on what applies in a state. Surety bonds are broadly categorized into two types, namely contract and commercial surety bonds.
- Contract Surety Bonds
Contract surety bonds usually required by government agencies to serve two primary goals. It helps ensure that a contractor completes a project he undertakes. Also, it helps to ensure subcontractors are paid the agreed sum by the contractor. It has three major types, which are:
- Bid Bonds: A bid bond is used when bidding for a contract. It is to show that your company is financially capable and has all the required resources to get the job done.
- Performance Bonds: If you are choosing for the project, you will be required to present a performance bid to guarantee satisfactory completion of the project. In case of failure to complete the job as agreed, the surety company will be held responsible for the completion.
- Payment Bonds: If all things went as planned and the project is completed, then you will need to pay your subcontractors. A payment bond is to ensure that all parties that worked on the projects are as agreed.
- Commercial Surety Bonds
There are thousands of bond types under this category, and each is named after its purpose. They are mostly required in license or business registration, or legal cases. Examples are License and Permits Bonds and Court Bonds