- January 28, 2016
- Posted by: Liam Dai
- Category: Surety Bonds
The purpose of a surety bond is essentially to work as a risk transfer mechanism. In the most basic sense, a surety bond is an agreement between three parties: the principal, the surety, and the obligee.
- Principal: A person required to post bond.
- Obligee: A government entity or person requiring the principal to be bonded.
- Surety: A person or institution that provides a financial guarantee to the obligee on behalf of principal.
Each party has their own role: the surety provides a financial guarantee to the obligee ensuring that the principal will fulfill their obligations. To clarify, a principal’s obligations may mean meeting the terms set out for a construction contract, successfully complying with environmental regulations related to a particular business license, and so forth.
If the principal fails at meeting the obligations to the oblige, the surety may then be required to resolve the dispute and/or shortfall by paying a claim to the oblige. While we mentioned that a surety bond acts as a risk transfer mechanism, it also is similar to credit extended to the principal by the surety.
What Does a Surety Bond Guarantee?
Surety bonds feature guarantees that vary with the type of bond that is agreed upon. For the construction industry, a surety bond ensures that a bonded contractor fulfills their contracted obligations. If the contractor fails to fulfill the obligation and defaults, the surety guarantees the terms to the obligee, whether this is a financial payout or other actions to ensure that the original work is completed as specified.
In contrast, license and permit bonds guarantee that the principal fully understands and follows the regulations according to the regulations for their license. If you’ve ever seen the term “licensed and bonded,” this situation is where it originates. Examples of violating this surety bond can be fraud, late payment, and misrepresentation.
Furthermore, if a claim is filed against the bond that principal cannot resolve during the course of conducting business, the surety will be required to pay the claim on the obligee. This is why surety companies require the principal to sign an indemnity agreement with the surety, agreeing to pay back claims. If you have a surety pay a claim on your behalf, it will be difficult in the future to become bonded in the future.
Aren’t Surety Bonds Like Insurance?
It is helpful to understand what exactly a surety bond is. For starters, a common misconception about surety bonds is that they function as insurance for your business. This is false. On the contrary, surety bonds function as insurance for the public (ie. your customers) that you (the principal) are required to pay for.
An easy way to understand surety bonds is that they are a cost of doing business with the US government. In addition, most states require businesses to have a separate business liability coverage that protects them from loss and damages. To be sure that you’re adequately covered, be sure to speak with a qualified insurance agent today. [INSERT LINK TO RiskBlock]
Examples of Surety Bonds
If you’re still unsure of what a surety bond actually is and how they function, here are a few examples of surety bonds (in different forms) used every day:
- Business owners choose to buy business service bonds to protect their clients from employee theft.
- To work on publicly-funded projects, construction professionals need contract bonds before beginning work.
- Before receiving their business licenses, most individuals need permit and license bonds.
Of course, this is just small sampling of how surety bonds affect businesses. Consulting a surety specialist [Click here to have an advisor call you] can help ensure that you’re following the guidelines of your industry and pursuit.
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If you’re still vague on just what a surety bond (and variations) is, you’re not alone. While you may be used working on your business yourself, it takes those experienced in surety bonds, like the agents at RiskBlock to determine the best surety bond for you. Click here to have an advisor call you to begin putting the “sure” in surety.