A surety bond involves three parties: a business or individual, a surety company, and the obligee, and it is an agreement between them. The bond protects the obligee against financial losses incurred due to the principal’s contractual obligations up to a specified limit.
Businesses and individuals must often furnish a surety bond before being allowed to perform specific tasks or professional duties.
Protects the Obligee
Purchasing a surety bond is one of the ways an individual or business shows financial responsibility and their ability to fulfill a contract, legal obligation, or professional requirement. So, what is a surety bond, and what does it protect? The surety bonds protect third parties, such as customers, suppliers, and state taxpayers, from damages caused by the principal’s breach of bonding terms. Unlike insurance policies, funds are only paid out on a claim after it is validated and deemed prudent to do so by the surety company.
Obtaining a bond is the first step for many businesses or individuals to reduce risk and demonstrate their financial strength. However, it’s essential to understand that a claim against a bonded principal can result in them losing their professional license or being unable to perform on a project. This can have devastating consequences. The obligatee, or party protected by the bond, is also protected from paying for additional work and losses due to the bonded principal’s breach.
Protects the Principal
A surety bond is a contract between three parties that guarantees performance. The principal buys the bond to ensure they will fulfill their contractual obligation. The obligee, often a government agency or project owner, requires the bond to minimize financial risk.
The bonded principal must pay any claims against them up to the bond’s total value. They must also reimburse the surety company for any funds paid out to satisfy a claim.
In addition to protecting the obligee from financial harm, a surety bond protects consumers and hiring parties from any harm caused by the actions of a bonded principal. This includes sloppy work, dishonesty, sudden bankruptcies, and other issues that can cost consumers or the public money. Some common types of specialized commercial surety bonds include license and permit bonds required by government agencies for professionals, mortgage brokers, supply bonds, warranty bonds, and maintenance bonds. These bonds are typically required by law or as a part of contract terms.
Protects the Public
Surety bonds protect the public from fraudulent and unethical business practices that a bonded principal can commit. They also help screen out individuals with bad character and a history of taking advantage of the public or government. Surety bonds lower risk for lenders, and that, in turn, can reduce interest rates for borrowers.
The principal is the individual or business that purchases the bond. The obligee is the organization or individual who demands a bond as a prerequisite for obtaining a license or permit. For example, mortgage broker bonds are required by state law to guarantee that a bonded mortgage broker will adhere to regulations regarding their business. If someone suffers financial loss due to a bonded principal’s failure to complete a contractual task, they can file a claim against the bond to recover their losses. This is similar to how insurance works for consumers and businesses when they purchase policies.
Protects the Surety
A surety bond is more cost-effective than other forms of security. Using a surety bond can reduce the need for the principal to put up assets that would be directly accessible to cover situations that might amount to a claim on the bond.
It can also lower risk to the lender, which can help them offer lower interest rates for a small business that wants a fidelity bond to cover employee theft, fraud, or embezzlement. A surety bond also provides the benefit of a claims process that is less complicated than using a bank instrument for security. If a valid claim is paid out on a bond, the bonded principal is expected to reimburse the surety company for the amount paid. This helps the surety company maintain a good reputation as an issuer of bonds. An inadequate credit history can make it more difficult for businesses to obtain a surety bond. That is why it is essential to work with a reputable and experienced surety bond company when applying for a bond.
