What is a Surety Bond?

A surety bond is a generic term to describe many types of bonds. A surety bond is a three party guarantee. The three parties are:

• The principal - the primary person or business entity who will be performing a contractual obligation
• The obligee – the party who is the recipient of the obligation (usually a government entity)
• The surety - who ensures (guarantees) that the principal's obligations will be performed. Sureties are similar to (sometimes divisions of) insurance companies.

Through this agreement, the surety agrees to uphold - for the benefit of the oblige - the contractual obligations made by the principal if that principal fails to uphold its promises to the oblige. The surety bond is provided so as to induce the oblige to contract with (or license) the principal, i.e., to demonstrate the credibility of the principal and guarantee performance and completion per the terms of the agreement.

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.

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Surety bonds are frequently used in the construction industry.  In order to obtain a contract, the general contractor must provide the oblige (project owner) a bond for its performance of the terms as per the contract. Additionally, owners and contractors may also provide payment bonds to ensure that subcontractors and suppliers are paid for work done. Under the Miller Act of 1935, 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.

The principal (contractor, licensee, or permit applicant) will pay a premium, usually annually in exchange for the surety company's financial backing to extend surety credit. In the event of a claim, the surety will investigate it prior to payment. If it turns out to be a valid claim, the surety will pay the claim and then turn to the principal for reimbursement in the amount paid on the claim as well as any legal fees incurred in the process.