If a contractor defaults, then a surety bond can ensure that the contract is still completed as initially agreed upon. The owner of the project is called the obligee, and the contractor is referred to as the principal. Before the initial isolation of the project, the contractor gets in contact with a surety company in order to obtain the surety bond. In the event of a default, the surety company is tasked with compensating the obligee for any financial consequences. The surety company may also endeavor to find a different contractor who can successfully complete the contract where the previous contractor was not able to.
When would I need a surety bond?
If the obligee enters a federal construction contract with a value of $150,000 or more, then a surety bond is necessary for the awarding or bidding of the contract. There are a number of private entities, supply contracts, service contracts, and municipal/state governments that also necessitate a surety bond establishment.
In a sense, a surety bond serves as a form of insurance between the obligee, the principal, and the surety bond company. The surety bond is an alternative to the obligee using a cash deposit to initiate the project. Surety bonds are best-suited for those who are seek to bid on construction contracts.
Most commonly, the obligee is a government agency. The surety bond is in place in order to protect the best interests of both the government and its citizens. The obligee requires the principal to fund the surety bond, and any costs for performance bonds are reimbursed. Be advised that surety bonds should not be mistaken for indemnity bonds or “security bonds”. Indemnity bonds are specifically related to loans, and “security” bonds are simply a mispronunciation of surety bonds that don’t actually exist.
How does the surety bond work?
There are some who would refer to a surety bond as being of particular fusion of credit and ensure. With this form of insurance, the beneficiary is able to file a claim at any time that the promise of the bond is not met. The bonded party effectively has a form of credit, and the principal to the surety must repay the claim if it is filed.
“In the event that a surety bond is enacted, then every single cent of the claim must be paid in addition to the legal expenses,” said Simplebond Insurance Services, LLC. Even though the bond is funded by the surety company, there is an indemnity agreement, also known as the general agreement of indemnity that needs to be signed by the principal and all owners of their company.
Often times, those who are in search of bonds for the protection of their business will in accurately use the phrase surety insurance. In truth, there is no definition for surety insurance. Surety bonds are for the benefit of the obligee, not the principal. In the event that a business owner seeks to defend themselves against the threats of any foul play in their staff, then the best course of action would be to seek out fidelity bonds.
Essentially, the indemnity agreement serves to pledge the principles personal assets and corporate assets to the reimbursements of the surety in any events of a claim. In a way, the surety is a form of confirmation that the principal is able to substantiate the hypothetical claim that would be filed in the event of a contractor default.
What are the different kinds of surety bonds?
There are four types of surety bonds in total:
1. Bid Bond: A bid bond guarantees the bidder can and will provide the necessary payments and fund the performance bonds if they do get the contract award.
2. Ancillary Bond: The ancillary bond guarantees that all necessary requirements for the contract are performed.
3. Performance Bond: A performance bond guarantees that the contract will be completed without any deviation from its explicit terms.
4. Payment Bond: A payment bond guarantees that every subcontractor/supplier is compensated for their work under the terms and conditions of the contract.