A surety bond is a financial guarantee that certain obligations will be fulfilled as per a contract or agreement. Essentially, a surety bond acts as a safeguard for one party, ensuring that the obligations or promises made by another party are carried out in good faith. The bond involves three key parties:
In this guide, we will explore the various types of surety bonds, how they work, their uses, and how businesses and individuals can obtain them. We’ll take a closer look at the importance of surety bonds and why the global market for bonds is set to grow to $27 billion by 2030. We will also examine how bonds deliver lower costs of completion as well as payment protections for workers, subcontractors and suppliers.
By understanding the specifics of surety bonds, we think it’s easy to see how projects and contracts can proceed smoothly, with minimized risks, and with all interests protected fairly. Let’s start with how surety bonds work.
Surety bonds are based on a legally binding agreement between three parties (as outlined above). The principal, which is typically a business or individual, purchases a surety bond to assure the obligee that they will meet the obligations as laid out in a contract or legal agreement. If the principal fails to meet these obligations, the obligee can file a claim against the bond.
If the claim is valid, the surety company steps in to compensate the obligee up to the bond’s value. The principal is responsible for reimbursing the surety for any paid claims. So, while a surety bond protects the obligee, it is ultimately the principal’s responsibility to ensure they fulfill their legal requirements.
Surety bonds can cover a wide range of obligations, depending on the type of bond involved. They safeguard government entities, businesses, and consumers from financial loss by ensuring that bonded parties uphold their legal or professional responsibilities. If the bondholder fails to meet their obligations, affected parties can seek compensation by filing a claim against the bond.
For instance, surety bond requirements may include fulfilling a contractual project, adhering to industry licensing regulations, or responsibly managing estate assets.
Surety bonds are generally required when a contractual obligation must be guaranteed or when specific legal or regulatory compliance is essential. Some common scenarios include:
Surety bonds fall into two categories: contract and commercial surety bonds.
Used mainly in construction, contract bonds guarantee the fulfillment of contractual terms. Common types include:
These bonds ensure businesses comply with regulations. Examples include:
Costs range from 0.5% to 15% of the bond amount depending on factors like bond type, amount, and your credit.
Applicants with strong credit receive lower premiums. Poor credit may increase the cost. Industry and regulatory conditions can also affect pricing.
In the U.S., performance and payment bonds for small businesses may incur a Small Business Administration (SBA) fee of 0.6%. If unused, the fee is refundable.
Surety bonds can also provide economic benefits—building trust and even generating savings. For example, on a $35M project, bonds can save $141,000 in taxpayer money.
We know you are probably thinking that surety bonds sound a lot like insurance. And although both surety bonds and insurance provide financial protection, there are some key differences between them.
Surety bonds guarantee one party will fulfill its obligations to another party, while insurance protects the insured party from loss or damage. In a bond, the principal is ultimately responsible for reimbursing the surety if a claim is made. In contrast, insurance companies pay out claims directly without requiring reimbursement from the policyholder.