A surety bond is a legally binding contract entered into by three parties: the principal, the obligee, and the surety. The obligee, a government or a private entity, requires the principal, a contractor or a business owner to obtain a surety bond as a guarantee against future work or contract performance. Surety bonds are required in practically every profession in the U.S.
The surety is the company that provides a line of credit to guarantee payment of any claim. They provide a financial guarantee to the obligee that the principal will fulfill their obligations. A principal’s obligations could mean complying with state laws & regulations pertaining to a specific business license or meeting the terms of a written construction contract or service agreement.
If the principal fails to deliver on the terms of the contract entered into with the obligee, then the obligee has the right to file a claim against the bond to recover any damages or losses incurred. If the claim is valid, the surety company will pay reparation that cannot exceed the bond amount. The underwriters will then expect the principal to reimburse them for any claims paid.
What Are The Different Types Of Surety Bonds?
There are several types of Surety Bonds for various types of needs or requirements, but most fit into two categories:
Commercial Surety Bonds
Contract bonds, used heavily in the construction industry by contractors as a part of a construction contract, are a guarantee from a surety to a project’s owner (obligee) that a 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, particularly subcontractors and materials and particularly for federal projects where a mechanic’s lien is not available.
MAINTENANCE BONDS: Guarantee that a contractor will provide facility repair and upkeep for a specified period of time.
Commercial Surety Bonds
Commercial bonds represent the broad range of bond types that do not fit the classification of contract. They are generally divided into four sub-types and miscellaneous bonds:
License and Permit Bonds
Public Official Bonds
Benefits of Surety Bonds
Surety bonds are purchased by a principal because they are required, either by a government entity or as a condition of a contract. However, these bonds provide benefits for the principal as well. They are a cost-effective alternative to posting cash directly with a trustee or the obligee or providing an irrevocable Letter of Credit in lieu of a surety bond.
As the principal, you pay a small percentage of the bond amount to the bonding company (surety) to provide a guarantee to the obligee, rather than parting with your liquid cash. Basically, when you purchase a surety bond, it is a form of credit extended to you.
The cost of a surety bond is based on three factors:
Type of surety bond
Amount of the bond
The risk level of the applicant
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