Surety bond is a legal term that the general public hears a lot without fully understanding what it means. A short definition is that it is an agreement between three parties: an insurance company such as Meadowbrook Direct that guarantees an obligation will be met, the obligee who requires the bond, and the principal who is required to get a bond.
The exact purpose of a bond will vary depending on its required purpose. Although they serve the purpose of both credit and insurance for necessary purposes, they still confuse a lot of people. It’s important to read up on this necessary product that impacts a lot of people.
A Quick Definition
A short definition of a surety bond is that you pay the insurance and back it for the other party, known as an obligee. More often than not, the obligee is a government entity that requires a bond for the greater protection of other citizens. These differ somewhat from indemnity bonds, which are loan-related.
The Specifics of a Surety Bond
The obligee has a legal right to file a claim if the bond’s promises are not fulfilled. In the principal’s case, it is treated as a form of credit that they must repay.
It is always important to understand the seriousness of the legal obligation that comes with such bonds. Claims against a surety bond require full repayment, in addition to any legal costs. In addition to the surety, the bond also requires an indemnity agreement signed by the company and its owners. These agreements allow both personal and corporate assets to be used as reimbursement to the surety in the event of a claim and resulting legal costs.
One thing that principals need to be aware of is that these bonds are only an issue in the event of a claim. In cases where the obligee is wrong, they are responsible. Understanding how this system works is essential for both the obligee and principal.
How is a Surety Bond Different from Insurance?
Many people incorrectly refer to surety bonds as surety insurance, despite their being different from liability insurance policies. They serve as insurance for the obligee, not for the principal who bears most of the liability. Principals who are concerned about liability need to be aware of this crucial difference for the protection of themselves and their customers or clients.
How Principals Go About Getting Bonds
Because there are many different bond requirements used throughout the US, it is necessary to know which type of surety bond is the right option. An obligee will be able to reject the incorrect type, which delays things for everyone all around.
Some of the specific surety bond types include:
- Fidelity bonds, which are bond insurance and not always required
- Court bonds, required under the court system for legal purposes
- License or miscellaneous bonds, required by law for non-contract purposes, such as licensing
- Contractor bonds, required for specific contacts, particularly jobs over $100,000
Are These Bonds Truly Worth It?
Many people wonder what the purpose of a bond is if they still bear liability. They serve as insurance to the obligee, but surety credit for the principal. Using bonds makes sense when considering the alternatives, that include posting cash with an obligee or trustee or an Irrevocable Letter of Credit in place of a surety bond, both of which have serious downsides:
- A greater risk of bankruptcy or default on the part of the principal
- False claims that occur without serious investigation
- Decreased capital from posting assets, thus affecting liquidity
- Having to provide 100% collateral, thus losing investment income
Ultimately, most companies decide that the downsides to not using surety bonds outweigh the costs of getting them. If you’ve been on the fence about this as an option, hopefully, these facts will have given you enough information to make your decision. You’ll be more likely to include the potential consequences in your decision by knowing what is at stake.