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What is a surety bond?

A surety bond is a legally binding contract that typically involves three parties: the principal, the obligee, and the surety, in which a surety (or insurer) financially guarantees to an obligee that the principal (or obligor) will perform in accordance with the terms established by the surety bond if the principal is in default. These types of contracts are most common in situations where a contractor performing work or services is at a relatively high risk of default. By involving a third party with the resources to pay the debt, the obligee--often a government entity--reduces the risk of a bad outcome.

In cases where the performance of work or services does not fulfill expectations, the surety bond is in place to reassure the obligee that the principal (or contractor) will meet obligations. In cases where the principal fails to do a satisfactory job, the obligee can file a claim with the surety. A surety bond is different from an insurance policy, which is usually an agreement between two parties.

There are different types of surety bonds, including:

  • A bid bond, which guarantees compensation to the bond owner if the bidder fails to begin a project and gives the owner assurance that the bidder has the financial means to accept the job for the price quoted in the bid.
  • A performance bond, which is issued to one party to a contract as a guarantee against the other party’s failure to meet the contract’s specified obligations and is generally provided by a bank or insurance company to ensure a contractor’s completion of designated projects.
  • A payment bond, which a contractor posts to guarantee payment to its subcontractors and material suppliers on a project; the federal government requires payment bonds for 100% of the contract value on contracts over $35,000 and a payment bond is often required in conjunction with performance bonds.

Synonyms for surety bond
The term surety bond insurance is often used in the same manner as surety bond. These two terms are used interchangeably

 


Learn more about surety bonds

When do I need to be aware of surety bonds?

If you are an entity entering into an agreement with a party whose financial situation or reputation is suspect, you might want to pursue a surety contract. This protects your company or agency from financial losses due to a contractor that does not meet expectations. The surety bond will be used to pay your claim, provided it is valid, and then the surety party will seek redress from the principal or the contractor.

What is important to know about surety bonds?

A surety bond is a financial mechanism that ties three parties together in a legally binding contract. The parties include an organization that is performing a work or service often known as the principal or contractor, an entity receiving this work or service often known as the obligee, and a guaranteeing party often known as the surety. There are some other important items you should know about surety bonds:

  • The obligee directs the contractor to get a surety bond to incentivize work performance.
  • The obligee can file a claim against the bond to make up for losses or damages.
  • The restoration amount paid out by the surety cannot exceed the bond amount.