A surety bond is a promise to be liable for the debt, default, or failure of another. A surety bond protects the party known as the oblige –the entity to whom the bond is paid to in the event of a default – against losses, up to the limit of the bond. These losses result from the principal’s – the party with the guaranteed obligation – failure to perform its obligation such as the completion of a project. The surety, for example, an insurance company, assumes the obligation if the principal cannot.
The bond assures the oblige that the principal will act in accordance with certain laws. If the principal fails to perform in this manner, the bond will cover resulting damages or losses. Although often overlooked, depending on your country, surety bonds are very important. Some countries have made them a requirement when reaching out for government contracts above a certain threshold.
It is important to note that surety bonds do not replace insurance for your business, and it is not the same as workers’ compensation insurance.
How Does Surety Bonds Work?
Surety bonds provide financial guarantees that contracts and other business deals will be completed according to mutual terms. Surety bonds protect consumers and government entities from fraud and malpractice. When a principal breaks a bond’s terms, the harmed party can make a claim on the bond to recover losses. The surety company then has the right to recover these monies from the principal in the case of a paid loss or claim.
Surety Bond Requirements
Surety bond requirements vary according to location, but there are a few things that remain constant. Principals must show they have good credit and a good reputation before a surety company will grant them a bond guarantee. They must show to some degree that they can manage the needs of the project. Surety companies often require principals to show they have the equipment, experience and financial resources to carry out the contractual obligations.
Surety Bond Examples
Examples of surety bonds comprise advance payment, trade guarantees, construction, performance, warranty, and maintenance bonds.
Let’s consider a real-life scenario.
A local government agency (Obligee) wants to construct an office building. They decide to hire Mr. Contractor (principal) for the job. Mr. Contractor is required by the local government agency to secure a construction performance bond to guarantee that they will fulfil the terms of the contract. Mr. Contractor will buy a construction performance bond form a reliable and trusted surety company.
If Mr. contractor fails to complete the project, they then default. The local government agency can, in turn, make a claim on the bond with the surety company. The surety company can now recover these funds from Mr. Contractor over time according to the surety contract.
How to Get a Surety Bond
You can get a surety bond from an approved surety agency that is licensed in your locale. Go in prepared, know the kind of bond you need and the amount. Most surety agencies will know the bond type and amount your industry requires but being prepared speeds up the bonding process.
Once you’ve contacted the surety agency, they will work with you to provide a suitable and cost-effective option based on your needs.
Types of Surety Bonds
Contract Bonds and Commercial Bonds are two main types of surety bonds. Contract bonds are used mainly in the construction industry and guarantee a specific contract. Examples include Performance Bonds, Bid Bonds, Supply bonds, Maintenance Bonds and Subdivision Bonds. Commercial bonds satisfy the security requirements of public, legal and government entities and protect against financial risk. These bonds guarantee that the business or individual will comply with all required legal obligations.
Surety bonds help to protect the financial interests on all parties involved in the contract. While they may seem complicated, there is always help available to get started. At Risiko, we can help. We protect your company through bonds and insurance.