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surety bond, often referred to as a contractor license bond, is a contract between three parties, often used in the business world, particularly within the context of construction projects. These so-called contractor bonds are fundamental in order to carry out jobs in construction that require guarantees of performance and completion.

  1. The Obligee - this is the party that is getting the benefit of the contract. A lot of times this is the government.
  2. The Obligor - this is the party that needs the bond to guarantee their obligation. That obligation can be a contract that they are working on (such as a general contractor), or a guarantee that they pay their taxes, such as with a license bond.
  3. The Surety - this is the party that is guaranteeing the performance of the Obligor.

What are Surety Bonds? What is a surety bond? A surety bond is a three party contract where the surety company assures the financial guarantee of the Obligor to the Obligee. Pictures of obligor, obligee, surety company on multi colored background, handshake, construction

updated November 2019

What is a Surety Bond?

surety bond is an agreement where the surety (the party that issues the contractor license bond guarantee, typically a reputable insurance company) works with another party (called the principal) and guarantees the principal's work for the benefit of a third party (the Obligee). This type of contractor bond is especially crucial in scenarios where the principal has duties such as meeting certain construction requirements or regulations as set by a court or other regulatory body.

How Does a Surety Bond Work?

A Surety Bond is a three-party contract. In this agreement, the Principal joins into the agreement with the Surety to guarantee the work for the benefit of the Obligee (the third party). Obligee: The party (corporation, person, or the federal government) that receives the benefit of the bond. In a place such as a construction scenario, the owner of the property is typically the Obligee as they will get the construction bonds payment if there is a default. The principal would typically be a construction company that the Obligee requires to be bonded (this is You).

What Do You Need a Surety Bond for?

Surety: Usually the surety is a large insurance corporation who provides the guarantee of the Company/Obligor by ordering a contractor license bond. The bond works by providing that the Obligor/Contractor performs timely and builds according to the terms of the contract. If not, the Obligee can stake claims on the contractor bond and then the Surety would provide money or find another contractor to finish the work. The surety bond is a permit of sorts, allowing the principal to take on duties that, if not undertaken properly, could lead to questions of liability.

Types of Surety Bonds

Bid Bonds

bid bond guarantees that the bonding company (“surety”) will provide a performance and payment bond on behalf of the principal once the principal is awarded the contract. A claim can be filed against the surety if they refuse to write the performance bond—an action that would typically involve their insurance company.

Performance Bond

A bid bond, another form of contractor bond, guarantees that the bonding company (“surety”) will provide a performance and payment bond on behalf of the principal once the principal is awarded the contract. A claim can be filed against the surety if they refuse to write the performance bond—an action that would typically involve their insurance company.

In the event of non-compliance, states may claim recourse through the contractor license bond. A performance and payment bond is the contract surety bond that is used once the contract is awarded. A performance bond protects the owner from financial loss in the event that the contractor fails to perform the contract in accordance with its terms and conditions. Most performance bonds include a provision that covers the workmanship and quality of the project for one year after completion, serving as an indemnity for the project owner against any faulty work done by the contractor or subcontractor. A performance bond usually includes a payment bond as part of the P&P bond being provided. It is, in a way, the surety's approach of meeting its contractor's obligations, duties, and costs laid out in the agreement. This process affords numerous benefits to all parties involved in a construction project.

Payment Bond – A payment bond, also known as a material and labor bond, protects certain specified tiers of subcontractors, material suppliers, and laborers against the contractor not paying. In general, these claimants have a tendency to look to get paid directly by the surety company pursuant to the terms of the payment bond. This bond, presented with the contractor's logo, is an essential element of business, especially when dealing with significant construction projects.

What does the term “bond” really mean? Unfortunately, there are a lot of bonds out there – from surety bonds to treasury bonds to other bonds, James Bonds. This is a simple explanation of a surety bond, which might help answer your questions. A guarantee bond or surety is a promise to pay someone, called the obligee, a specific dollar amount if someone else, called the principal, fails to comply with some commitment. These commitments are typically something that is specified in a contract and are especially common in construction bond contracts. The surety bond safeguards the obligee against losses arising from the principal's failure to comply with the commitment, it's a key ingredient for a smooth business transaction.

What Are Surety bonds?

A typical surety bond contains three different parties, who all have important functions and duties in this binding business arrangement:

Parties to a Surety Bond

A typical surety bond involves three different parties, each playing a crucial role:

  1. The obligee – this is the person that gets paid if someone else doesn’t do what they said they’d do under the contract that the surety bond protects;
  2. The principal – this is the person who made the commitment under the surety bond; and
  3. The surety – this is the person that pays the obligee because they assured the obligee that the principal can do the job.

A side note – European surety bonds, an integral part of the indemnity process, are issued by banks and are called “Bank Guarantees” in English and “Caution” in French. They pay money to the limit of the guarantee in the event of the default of the Principal of his obligations to the Obligee, without referring by the Obligee to the Principal and against the Obligee's single confirmed declaration of case to the bank.

Back to the US – with a surety bond, the surety agrees to support, for the benefit of the obligee, the legal guarantees (commitments) made by the principal if the principal fails to uphold its promises to the obligee. This benefits both the construction project owner and the contractor in question.

The contract is formed so as to cause the obligee to deal with the principal, i.e., to show the trustworthiness of the principal and guarantee performance under the surety bond. The process therein provides the obligee, often a project owner, with some comfort regarding the principal so that they can form a successful contract with the principal.

The principal, in return for the surety’s (bonding firm) fiscal backing, will pay a price (usually annually or per job). The principal is willing to pay for the surety bond as it allows them to secure the contract and embark on a profit-generating project.

So, what happens if the principal cannot perform under the contract that is secured by the surety bond? In such a circumstance, the surety, adorned with its logo, will investigate the situation and determine if there is a valid claim under the terms of the surety bond, thereby minimizing potential costs to the obligee (sometimes, the obligee complains, but that complaint is without merit).If a claim is valid, the surety will pay it per the terms of the contract bond. As part of this agreement, the surety then looks to the principal for reimbursement of the amount paid on the case and any lawful charges sustained. This often involves the agency responsible for managing the contractor license as well as its policies towards its employees.

So, what happens if the principal defaults and the surety is also insolvent? In those cases, the surety bond in question, let's say in California, is worthless. That’s why the guarantee on a bond is normally an insurance policy company with solid underwriters whose solvency is verified by personal audit, government policies, or both. Just as a guide to help you understand, nearly all surety bond companies are T-Listed and A++ rated, so the guarantees under the surety bond are pretty solid. It's also important that an application for a surety bond considers the credit history of the applicant.

What is a Contractor Surety Bond? The image shows two contractors looking at their blueprint at the table. A contractors equipments.

Surety Bonds - Three Party Agreements

Contractors are always concerned that their products or services will not be delivered as promised. The thought of being left with nothing to show for all the time, effort, and money they have invested can make them hesitant to take on new projects—especially if this project requires an upfront payment from customers before any work begins. A surety bond, a contract bond to be precise, helps level out these risks by promising some form of compensation in case things go wrong (or when there's just no more cash coming in).

What is a Surety Bond and How Does it Work?

The surety bond or contract bond is a type of agreement that one party (the surety) will be liable for the debt, default, or failure of another. This includes a three-party contract between the obligee, the principal, and the surety, each with defined roles and responsibilities. The agency that oversees the contractor license will usually have specific guidelines and policies for such agreements.

Fidelity Bonds - Another Type of Surety Bonds

A few examples of this type of contract bond arrangement include liability insurance contracts such as health care provider malpractice coverage and automobile lien holder bonds which protect you even though we do not know who may ultimately cause harm against someone else - like car accidents often result in financial damages inflicted on people, posing a significant risk to the overall investment and market value.

Bonds Guarantee Performance or Repayment

The surety bond is an agreement that one party (the surety) will be liable for the debt, default, or failure of another. It's a three-party contract between third parties where there are two different aspects: The obligee agrees to accept protection from the obligation and responsibility owed by the principal in exchange for being appropriately compensated when things go wrong; meanwhile, it also stipulates how much money should be paid if something does happen with said obligations. Every bond is seen through by underwriters, ensuring that the applicant's credit is suitable for a contractor license.

Are Surety Bonds Legally Binding?

A few examples of this type of contract bond arrangement include liability insurance contracts such as health care provider malpractice coverage and automobile lienholder bonds which protect you even though we do not know who may ultimately cause harm against someone else - like car accidents often result in financial damages inflicted on people, posing a significant risk to their credit score.

A few examples of this type of arrangement include liability insurance contracts such as health care provider malpractice coverage and automobile lienholder bonds which protect you even though we do not know who may ultimately cause harm against someone else - like car accidents often result in financial damages inflicted on people.

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