Surety Bond Definition Explained
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A surety bond can be defined as a financial guarantee that contractual obligations will be met. If they are not, the surety provider ensures third parties are reimbursed for damages.
In other words, it is a guarantee by a third party to assume responsibility for repayment of another party’s debts if they fail to uphold contract terms.
What Are the Parties Involved in a Surety Bond Contract?
Surety contracts are formed when a surety bond is issued between three parties:
- A principal who needs the bond
- An obligee who requires the bond
- A surety that provides the bond
The bond guarantees the principal will act in accordance with certain laws. If the principal fails to do so, the surety will cover resulting financial damages.
What Is the Purpose of a Surety Bond?
Surety bonds provide financial guarantees that contracts and other business deals will be completed according to mutual terms. Their primary purpose is to protect consumers and government entities from loss due to poor workmanship, malpractice, theft and fraud.
What Is an Example of a Surety Bond?
When a principal breaks a bond's terms, the harmed party can make a claim on the bond to recover losses. For example, most municipalities require construction bonds on public works projects. A public contractor must file a payment bond guaranteeing they will pay subcontractors and suppliers even if the contractor defaults.
In this example, the surety bond covers the municipality and subcontractors against financial harm, but it is not insurance. The bonded contractor must fully repay the surety for any claims.
What Is a Surety?
The surety in a bond contract refers to the company that issues the bond. Bonds are a form of financial security, and the surety is the entity that backs the bond. In doing so, a surety takes on responsibility for another’s debt.
What’s the Difference Between Sureties and Guarantees?
Guarantees and sureties are both legal instruments that create more security in business contracts. You may hear the terms used interchangeably, but the legal definition of a surety bond is different from a guarantee.
- Sureties: Join the business deal as a third-party and offer a layer of security that the contract will be fulfilled by issuing a surety bond.
- Guarantees: Create an independent financial commitment outside of the contract in which the guarantor is financially responsible if the principal defaults.
