Every business transaction involves an element of uncertainty. The goods or services offered may not turn up or may be noticeably short of established standards. In a week economic environment this uncertainty can cause further impediment in the business environment.
This is where surety bonds come in. A surety bond is a promise or guarantee to one party (the obligee) in case the second party (principal) fails to meet a contractual obligation. It is means to protect the obligee against any defaulting by the principal party. These bonds are a means of ensuring that the initial investment is protected against any default at a later stage.
There are three parties in a surety bond. These are:
The principal:This is the party that is required to discharge the contractual obligation. It can be a government body or a private business.
The obligee:This is the party that needs or is the recipient of the bond.
The surety:Typically an insurance company that guarantees the completion of work by the principal.
Working of a surety bond:
Surety bonds are often part of the initial offer for a given project. In some cases, the obligee is legally obliged to ask for a surety bond. For instance, contracts over $100,000 require a surety bondunder the Miller Act. The obligee asks for the bond to ensure that the principal feels a commitment towards finishing the given task.
The surety bond is demanded during the contract phase as a condition of being awarded the task at hand. The principal must then supply the bond to the obligee. The principal can buy this bond from a surety bond agency, usually an insurance company. The insurance company will, in turn, ask for an insurance against the bond.
This is in the form of an indemnity agreement where the owner or owners of the principal company are required to pledge their personal or corporate assets to reimburse the surety amount and any associated legal costs. This is meant to show that you have the economic wherewithal to bear the brunt in case the work falls short. In other words, the insurance company requires this to ensure that their own liability is protected.
The aim of the surety bond, thus, is to ensure strict compliance of the principal party towards the contract. It enforces a penalty in case of any default, thus ensuring that the contract is discharged properly. It also ensures that the financial losses to the obligee are minimized.