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Surety Bond – Types, Working and Benefits

A surety is an agreement that one party makes with a promise to comply, pay financial obligation/s, or, perform or refrain from a specific task. A surety bond is a three-party contract where surety guarantees obligations of principal to obligee. To know more about surety bonds go through this blog.   

What Are Surety Bonds?

Surety bonds are legally binding contracts that a minimum of three parties enter. To use lender-borrower terminology: A surety bond ensures that issuer of a particular bond (1st party:  surety) will pay the debt amount to the lender (2nd party: obligee) if the borrower (3rd party: principal) fails to pay the debt. 

  1. Surety – Ensures that Principal would make payment 
  2. Obligee – Needs Principal’s guarantee. 
  3. Principal – Has to obtain the bond and fulfil obligations. 

Types of Surety Bonds

There are three main types of surety bonds and those have various subtypes:

1. Contract Surety Bonds 

Contract surety bonds are bonds that provide guarantees for construction projects. There are four types of contract surety bonds

  1. Performance Bond
  2. Bid Bond 
  3. Payment Bond 
  4. Warranty/Maintenance Bond

2. Commercial/Miscellaneous Surety Bonds  

Commercial surety bonds cover a wide range of surety bonds. Local governments, states, and other entities require this type of bond for businesses and individuals. It can be divided into five types: 

  1. Court/Judicial Bonds 
  2. Licence and Permit Bonds 
  3. Fiduciary Bonds 
  4. Miscellaneous Bonds 
  5. Public Official Bonds

3. Fidelity Bonds

Fidelity is a form of insurance that protects employers from dishonest or fraudulent acts of their employees. It has various types of bonds including: 

  1. Standard Employee Dishonesty Bonds 
  2. Employee Retirement Income Security Act of 1974 Bonds 
  3. Business Services Bonds 

How Do Surety Bonds Work?

As mentioned earlier, there are three participants in surety bond insurance: Surety, Obligee, and Principal. 

Principal’s responsibility is to obtain surety bond which includes total money that it owes and other specific conditions. 

If Principal defaults on the contract, then Obligee can file a claim and seek indemnity. 

The Surety, being the issuer of these bonds, can review the claim and make a decision. If the surety has to compensate or pay the obligee, it can claim restitution from the Principal. 

This compensation to a Surety includes principal amount, interest and fees. 

Benefits of Surety Bonds

Here are some advantages of a surety bond

  1. Being an impartial third party, Surety can verify that a Principal (e.g. a contractor) is qualified and capable. 
  2. Obligee or the owner has an assurance of completion of a concerning project. 
  3. The owner benefits from the protection that the Surety offers in case there is a contract breach. 
  4. A surety will provide financial, managerial, or technical assistance to the principal while abiding by the contract. This reduces the likelihood of a default and helps a project move forward. 
  5. On public projects, a surety bond protects taxpayers’ money. 
  6. Suppliers and subcontractors can offer lower quotes as they get the assurance of payment. 

How to Get a Surety Bond?

Follow these steps to get a surety bond

  • Step 1: Figure out the bond requirements for your specific industry or business in your state. 
  • Step 2: Confirm the amount you need for bond coverage. 
  • Step 3: Get hold of a surety company that can sell bonds in your state or contact a speciality surety agent. 
  • Step 4: Furnish the financial information and business details essential for the quote and receive your bond quote. 
  • Step 5: Sign all policy paperwork. 
  • Step 6: Pay the premium and obtain your surety bond
  • Step 7: Provide the bond information to the entity that requires it.  

Surety bonds are financial instruments that legally bind the Principal, the Obligee, and the Surety together to ensure that there is no breach of contract. Surety takes responsibility for the default or other financial responsibilities of another party. It lowers the risk for lenders and can also reduce interest rates for a borrower.  

FAQs

Is surety bond legal?

Yes, Surety bonds are legally binding contracts. It can bind three or more parties.

Who issues insurance surety bonds?

In India, any general insurance company that has the capability to provide extensive reinsurance support and is in a position to legally enforce tripartite contracts (that guarantee performance and/or payment) can issue insurance surety bonds 

What is the difference between a surety bond and a bank guarantee?

A surety bond does not require collateral. On the other hand bank guarantees however need collateral.

Are surety bonds refundable? 

Generally, during the initial year, surety bonds are non-refundable. However, in certain cases, some sureties make an exception.

What happens if surety cannot pay? 

When a principal debtor defaults, a creditor can directly sue the surety. However, the surety’s responsibility to pay is secondary as a creditor cannot ask for payment until the principal debtor actually defaults.

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Stable Money

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