A surety bond is a contract among at least three parties:
- The principal - the primary party who will be performing a contractual obligation
- The obligee - the party who is the recipient of the obligation, and
- The surety - who ensures that the principal's obligations will be performed.
Through this agreement, the surety agrees to uphold - for the benefit of the obligee - the contractual promises (obligations) made by the principal if the principal fails to uphold its promises to the obligee. The contract is formed so as to induce the obligee to contract with the principal, i.e., to demonstrate the credibility of the principal.
There are two main categories of bond types: contract bonds and commercial bonds. Contract bonds guarantee a specific contract. Examples include performance, bid, supply, maintenance and subdivision bonds. Commercial bonds guarantee per the terms of the bond form. Examples include license & permit, union bonds, etc.
Suretyship bonds originated hundreds of years ago as a mechanism through which trade over long distance could be encouraged. They are frequently used in the construction industry: in order to obtain a contract to build the project, the general contractor (and often the sub-contractors as well) must provide the owner a bond for its performance of the terms of the contract. Conversely, owners and contractors may also provide payment bonds to ensure that subcontractors and suppliers are paid for work done.
Examples of Surety Bonds:
Under the Miller Act, payment and performance bonds are required for general contractors on all U.S. federal government construction projects where the contract price exceeds $100,000.00.
Surety bonds are also used in other situations, for example, to secure the proper performance of fiduciary duties by persons in positions of private or public trust.
A key term in nearly every surety bond is the penal sum. This is a specified amount of money which is the maximum amount that the surety will be required to pay in the event of the principal's default. This allows the surety to assess the risk involved in giving the bond; the premium charged is determined accordingly.
If the principal defaults and the surety turns out to be insolvent, the purpose of the bond is rendered nugatory. Thus, the surety on a bond is usually an insurance company whose solvency is verified by private audit, governmental regulation, or both.
The principal will pay a premium (usually annually) in exchange for the bonding company's financial strength to extend surety credit. In the event of a claim, the surety will investigate it. If it turns out to be a valid claim, the surety will pay it and then turn to the principal for reimbursement of the amount paid on the claim and any legal fees incurred.
A bail bond is a type of surety bond used to secure the release from custody of a person charged with a criminal offense. Under such a contract, the principal is the accused, the obligee is the government, and the surety is the bail bondsman.
Examples of fidelity bonds:
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