What Are Surety Bonds Used For
A legally enforceable agreement that ensures the fulfillment of an obligation or the payment of compensation in the event that the obligation is not met is known as a surety bond.
Surety bonds provide several advantages for businesses, including protection against dishonest employees, compliance with the terms of government contracts, and recovery of damages that have been decreed by the court.
In its most basic form, a surety bond stipulates that the surety must make a predetermined monetary payment to the obligee in the event that the principal fails to fulfill a contractual duty. Obligees are often governmental bodies. However, surety bonds may also be used by parties in the business and professional sectors. Surety bonds provide principals, who are often small contractors, with an advantage in the competition for contracts by ensuring clients that they will get the product or service that was promised.
The principal is required to make a premium payment to the surety, which is often an insurance company, in order to secure a surety bond. The principal is required to sign an indemnification agreement as a condition of obtaining a surety bond. This agreement makes a commitment to compensate the surety for any losses caused by a claim. In the event that these assets are inadequate or cannot be collected, the surety is responsible for satisfying the claim using its own funds.
Three Parties Involved
- The obligee is the party that needs reassurance that the principal will fulfill their obligations.
- The principal is the party who is responsible for fulfilling their end of an agreement.
- The surety is the entity that guarantees that the principal will fulfill its commitment and is the issuer of the surety bond.
When Is the Use of a Surety Bond Required?
When a contractor seeks to take part in a high-priced government contract, they will often be asked to provide a surety bond. When a contract needs performance, surety bonds make sense even when they are not required because they help pay obligees when principals fail to satisfy their contractual commitments. Yet, even when they are not required, surety bonds make sense when a contract requires performance. Before providing funding for a project in the construction business, certain lenders may stipulate that the endeavor must first be bonded.
Kinds of Surety Bonds
- Commercial Surety Bond
To ensure the protection of public interests, governmental institutions often need the purchase of a commercial surety bond. In most cases, licensed firms are required to purchase these bonds in order to guarantee that they comply with all legislation and standards that are related to the safety of the general public. Notaries, licensed professions, licensed professionals, lottery ticket vendors, liquor outlets, licensed contractors, as well as licensed automotive dealers are examples of typical principles.
- Contract Surety Bond
It is common practice to utilize a contract surety bond to guarantee the performance of a contractor (who, in this context, serves as the principal) in connection with a construction contract. In the event that the contractor is unable to finish the work, the surety business is responsible for finding another contractor to do the work or compensating the owner of the project for any financial losses. The cost of a contract bond is normally proportional to the value of the underlying contract and may vary anywhere from 0.5 percent to 3 percent of the total contract cost. Throughout the underwriting process, surety underwriters will take into consideration a number of factors about the contractor, including their character, cash flow, credit score, as well as work history.
- Court Surety Bond
Surety bonds offered by the court safeguard individuals or businesses against financial damage incurred as a result of legal proceedings. It is common practice for both plaintiffs and defendants as well as administrators of estates.
- Fidelity Surety Bond
Businesses that want to protect themselves against the dishonesty and theft of their employees often purchase fidelity surety bonds. They are essential for businesses that handle valuable goods or significant sums of money. For instance, if an employee of a credit union were to steal $10,000 by making up a loan that didn’t exist, the credit union might purchase a fidelity bond that would cover the loss. Businesses, as well as their current, past, and temporary workers, as well as directors, trustees, and partners, may all be protected by fidelity surety bonds.