Surety Bond
Several types of surety bonds exist depending on the industry and purpose of the contract. While some surety bonds also serve a judicial purpose, the most common types help businesses score new clients or earn government contracts by offering a performance guarantee.
What is a surety bond?
Essentially, a surety bond is a three-party agreement among the following parties:
- The principal. The party responsible for performing a contractual obligation
- The obligee. The party that benefits from the principal's obligation and is protected by the bond
- The surety. The party that promises to pay the obligee if the principal doesn't perform the obligation according to the contract
Often, these three parties translate into the contractor, client, and guarantor (respectively) in a business deal. The surety will guarantee payment to the obligee on behalf of the principal who the obligee hired to perform a service. The guaranteed amount is called the penal sum.
Surety bonds work similarly to an insurance policy. The principal pays a premium to the surety (often a surety or insurance company). In turn, the surety provides the principal with a surety bond that they can present to the obligee as a guarantee for services promised.
If the principal party fails to perform the obligation in accordance with the contract, they must default. In a default, the surety pays the obligee and seeks compensation from the principal. In this way, surety bonds offer a sense of security to the obligee while giving the principal an opportunity to prove themself. Surety bonds are especially helpful for small businesses building their clientele.
For a more in-depth understanding, read this article on the types of surety bonds and how to obtain one.
FAQs
When are surety bonds used?
Surety bonds are used in a variety of situations to guarantee that one party will fulfill their contractual obligation to another party. Commercially, construction companies may need to acquire a performance bond to secure a federal construction contract with a government agency.
In probate court, a trustee may use a surety bond to guarantee they’ll faithfully perform their fiduciary duty to the beneficiary.
Do you need a lawyer to write a surety bond?
Typically, rather than write a surety bond, you’ll file an application with an insurance or surety company that you trust. If they accept your application, you’ll fill out and sign paperwork to receive the bond.
While you don’t need a lawyer to fulfill this process, it can be extremely beneficial to have an experienced business or contract attorney in your corner to help you understand your rights and obligations.
What is the difference between a surety bond and a guarantee?
Surety bonds and guarantees are very similar in that they both provide financial assurance through a contractual agreement. However, a surety bond is a three-party agreement where one party (a surety) guarantees the obligations of another party (the principal) to a third party (the obligee). A guarantee is a two-party agreement where one party (the guarantor) promises to cover the debt of another party (the debtor) to a third party (the creditor).
How are surety bonds regulated?
Both state and federal laws regulate surety bonds. Rules also vary by industry, so it's important to research local industry requirements before applying for a surety bond.