What is a Surety Bond: Parties, Types, Requirements

A surety bond is part credit, part insurance that serves as a guarantee to ensure the fulfillment of obligations as specified in a legally-binding contract.

 

Who are the people involved in a surety bond?

What is a Surety BondA surety bond consists of a three-way party. Each party involved has a distinct role and responsibility with one another.

Obligee (Project Owner)

It is the party that requires and receives the benefit of the surety bond. It can be developers, local regulatory departments, state/federal courts or government agencies.

Principal (Contractor)

It is the party that purchases the surety bond and ensures compliance with obligations as stated in the terms of the contract.

Surety Company (Insurance Company)

It is the party that vouches for the principal. It promises to the obligee, through financial means, that the principal can accomplish and complete the contract obligation.

Simply put, the surety company promises to the obligee that if the principal defaults on a project, it will compensate with a penal sum (the maximum amount required to pay by the surety) to make sure that the project is successfully accomplished.

 

Why do you need a surety bond?

Because it is a requirement. Federal, state, and municipal governments require surety bonds to reduce potential risk on construction, commercial, and business projects and protect taxpayer money.

That said, let’s take a look at the several types of surety bonds:

Contract Bonds

They are also referred to as construction bonds. The construction industry specifically requires surety bonds for bidding on building projects. Surety bonds provide the obligee options to consider if things go haywire on the job. By requiring contract surety bonds, an obligee can pre-qualify principals and remove the ones that do not have the capacity to finish the project.

Commercial Bonds

They are often related to compliance with the laws and regulations that apply to the commercial industry.

License and Permit Bonds

They are required by the local, state, and federal governments as prerequisites for the permits and licenses of commercial projects in adherence to the local laws related to their field.

Court Bonds

They include judicial and fiduciary bonds imposed by courts. They can be appeal bonds, bail bonds or trustee bonds.

 

How come a surety bond is not insurance?

A surety bond is not the same as insurance in the traditional sense. It is part credit, part insurance where the surety company extends the credit in favor of the principal and offers financial coverage to the obligee in case a project is not completed.

 

How do you get a bond?

Surety bonds vary greatly; each obligee has a different set of requirements, each principal is involved in diverse situations, and each surety company offers specific options based on personal credit information, the type of risk, and the amount of bond it will cover.

Let’s say that you are a principal (contractor) looking to get a surety bond:

  1. First, determine the type of surety bond that is related to your industry.
  2. Seek for a reputable surety company in your state where you can fill a bond guarantee application form.
  3. Research about the bond premiums the surety company offers and ask for a computation.
  4. Once you have selected a bond premium, the surety company will furnish you a copy of the bond agreement.
  5. As agreed, you will have to pay the premium fee.
  6. Finally, you will get a signed copy of the agreement joined by the original copy of the bond and a Power-of-Attorney from the surety company.

Important to note: Even if you have provided all the essential information and requirements to the surety, there is no guarantee that your application will be approved. If the surety is confident that you are qualified to perform the obligations stated in the contract and have the financial capacity to confront risks involved in the project, you just might score approval and win that project bid.

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4 Responses

  1. Tyler Meredith

    I like that you talk about how contract bonds essentially just provide the obligee with options if the project doesn’t go as expected. It makes sense that this would be very beneficial for something like commercial construction to ensure the building is built in the estimated timeline because a lot of situations might have major complications if it’s not. Thanks for the post; this information really cleared up what the bonds do and how they’re helpful for many different situations.

  2. Ernest London

    Thanks for the information on surety bonds. I have heard people talk about surety bonds in the past, but I wanted to learn more about them. I didn’t realize that you actually need a surety bond if you want to do construction work. It makes sense that you would want to make sure all parties are covered in case anything goes wrong.