A surety bond or surety is a promise to pay one party (the obligee) a certain amount if a second party (the principal) fails to meet some obligation, such as fulfilling the terms of a contract. The surety bond protects the obligee against “losses” resulting from the principal’s failure to meet the obligation.
A surety bond is a contract among at least three parties
- The obligee – the party who is the recipient of an obligation,
- The principal – the primary party who will be performing the contractual obligation,
- The surety – who assures the obligee that the principal can perform the task
Through a surety bond, the surety agrees to uphold — for the benefit of the obligee — the contractual promises (obligations) made by the principal if the principal fails to uphold its promises to the obligee. The contract is formed so as to induce the obligee to contract with the principal, i.e., to demonstrate the credibility of the principal and guarantee performance and completion per the terms of the agreement.
The principal will pay a premium (usually annually) in exchange for the bonding company’s financial strength to extend surety credit. In the event of a claim, the surety will investigate and if the claim proves to be valid, the surety will pay and then turn to the principal for reimbursement of the amount paid on the claim and any legal fees incurred.
The penal sum, a key term in nearly every surety bond, is a specified amount of money which is the maximum amount that the surety will be required to pay in the event of the principal’s default. This allows the surety to assess the risk involved in giving the bond and determine the premium accordingly.
Contract bonds, used heavily in the construction industry, are a guarantee from a Surety to a project’s owner (Obligee) that a general contractor (Principal) will adhere to the provisions of a contract. Included in this category are:
- Bid Bonds – Guarantee that a contractor will enter into a contract if awarded the bid
- Performance Bonds – Guarantee that a contractor will perform the work as specified by the contract
- Payment Bonds – Guarantee that a contractor will pay for services and materials
- Maintenance Bonds – Guarantee that a contractor will provide facility repair and upkeep for a specified period of time
Commercial bonds represent the broad range of bond types that do not fit the classification of contract. They are generally divided into four subtypes: license and permit, court, public official, and miscellaneous.
License and permit bonds are required by certain federal, state, or municipal governments as prerequisites to receiving a license or permit to engage in certain business activities. These bonds function as a guarantee from a Surety to a government and its constituents (Obligee) that a company (Principal) will comply with an underlying statute, state law, municipal ordinance, or regulation. Specific bonds include: contractor, customs, tax, reclamation, broker’s, ERISA, motor vehicle dealer, money transmitter, and health spa.
Also known as employee dishonesty coverage, Fidelity Bonds cover theft of an employer’s property by its own employees. Though referred to as bonds, fidelity coverage functions as a traditional insurance policy rather than a surety bond.