Surety Bonds and How They Work
Updated: Feb 12, 2022
Surety Bonds perform an essential role in the construction industry. A Surety Bond is a three-way contract between the surety (the company providing the bond), the principal (the contractor), and the obligee (the project owner). The principal usually applies for the Surety Bond with the surety and it is to protect the obligee’s interest.
A Surety Bond is simply a three-party agreement or contract where the first party, the surety, guarantees the performance of the second party, the principal (contractor) if they default on their obligation to the third party, the obligee (the project owner).
The reason Surety Bonds work is simple. They help to take the risk out of a risky business. Surety Bonds are designed to protect your interest from the actions of a third party.
There are Four Major Categories of Surety Bonds:
There are a variety of Surety Bond types designed to meet your needs. In fact, almost any contract or obligation can be bonded. But, the four most common types of Surety Bonds include Contract Surety Bonds, Commercial Surety Bonds, Court Surety Bonds, and Fidelity Surety Bonds.
1. Contract Surety Bonds:
In the construction industry, one of the most common bond types are Contractor Surety Bonds. They include Bid Bonds, Performance Bonds, and Payment Bonds. All are needed for different purposes to ensure that the interests of the obligee are protected, especially if the principal fails to meet the terms of their contract.
Bid Bonds financially protect an obligee if the bidder awarded the contract fails to sign the contract and fails to provide the essential Performance and Payment Bonds.
Performance Bonds, on the other hand, are put in place to protect the obligee from monetary loss if the contractor fails to deliver the job according to their agreement.
Payment Bonds are there to guarantee that the contractor is going to pay the workers, subcontractors, and material suppliers involved in the project.
A Contract Surety Bond protects the project owner by guaranteeing that the contractor will follow the specifications and perform the work laid out in the construction contract. It also ensures that certain labor, materials suppliers, and subcontractors will be paid.
2. Commercial Surety Bonds:
Commercial Surety Bonds are Performance Bonds in which the surety (the company providing the bond), guarantees to the obligee (usually the public). The principal usually applies for the Surety Bond and are usually mandated by federal, state or local government agencies or private owners. The most common commercial contractors are manufacturers, wholesalers, or retailers – as well as all businesses with a license, get a Commercial Surety Bond. These bond types provide a guarantee by the principal of financial performance.
3. Fidelity Surety Bonds:
Fidelity Bond are a type of surety designed to protect a company or customers against specific types of loss that can include employee theft, malpractice due to forgery or false documentation, and general theft or fraud. Fidelity Surety Bonds typically protect against the loss of money, equipment, or personal supplies.
4. Court Surety Bonds:
Court Bonds are a general term used for all Surety Bonds that are needed by individuals when they are involved in pursuing action through a court of law. A Court Surety Bond can also be required by an attorney or similar entity before a court proceeding to ensure protection from a possible loss. These Court Surety Bonds typically guarantee the payment of costs associated with lawyer fees or appealing a previous court’s decision. Other Court Surety Bonds protect an estate against malpractice of the estate’s administrator.
Court bonds can be divided into two main categories: Judicial Bonds and Fiduciary/Probate Bonds. The main difference is that a Judicial Bond promises the payment of a sum of money that would be required in a court case, while a Fiduciary Bond only promises faithful and honest performance of a duty.