What is Surety Bond
A surety bond is an agreement. It involves three parties and served as protection for an entity, typically the client. Imagine the scenario of a complex commercial construction accepted by a contractor, and the client requires a safety net. In even the contract obligation is unable to be fulfilled by the contractor, the client will suffer financially. Under these circumstances, a surety provider, most of the time, an insurer will step in.
Surety always involves three parties:
- Obligee: the party to whom the bond is payable in the event of a default;
- Principal: the party on whose obligation is guaranteed; and
- Surety: the party that assumes the obligation if the principal cannot.
A surety is a form of financial credit known as a bond guarantee. The transaction always involves three parties: the obligee, the principal, and the surety. A surety bond protects the obligee (the party to whom the bond is paid to in the event of a default) against losses, up to the bond's limit, resulting from the principal's (the party with the guaranteed obligation) failure to perform its obligation. The surety, for example, an insurance company, assumes the obligation if the principal cannot.
A surety bond protects the obligee against losses, up to the bond's limit, resulting from the principal's failure to perform its obligation or undertaking. Unlike insurance, a loss paid under a surety bond is fully recoverable from the principal.
How do surety bonds work?
Principals act accordingly by specific laws with backing by surety bonds. The bond will provide obligees with financial guarantees that contracts and other business deals will complete according to mutual terms. Should the principal unable to fulfill the mutual terms, the obligee can claim the surety bond to recover losses. The surety company then has the right to reimbursement from the principal in the case of a paid loss or claim.
Common types of surety bonds
Two of the most common forms of surety are contract surety and commercial surety. The Surety Association of Canada explained the two as the following :
Contract surety - Contract surety bonds are used primarily in the construction industry. These bonds protect the owner (obligee) from financial loss if the contractor (principal) fails to fulfill their contract's terms and conditions. Should the contractor's inability to complete a job, the bond will compensate the obligee.
Commercial surety - Commercial surety bonds satisfy public, legal, and government entities' security requirements and protect against financial risk. These bonds guarantee that the business or individual will comply with all required legal obligations.
Surety bonds are especially important in the construction industry. They typically come in three types:
- Bid bonds are sometimes required by governments to guarantee that contract bids are made right.
- Performance bonds – these ensure the construction work will be completed on time and to the required standard.
- Payment bonds give financial protection to subcontractors and others who provide services and materials to the construction company.
Industry Licensing Requirements
Surety bonds are regulated and issued only by companies licensed federally or provincially approved by insurance regulatory bodies. Applicants must demonstrate financial solvency and sufficient strength to meet potential claims obligations. Only firms licensed to sell surety bonds in Canada may become members of the Surety Association of Canada.
How will the principal be granted the surety?
Principals have to show they have good credit and a good reputation before a surety company will grant them a bond guarantee. Surety companies often require principals to show they have the equipment, experience and financial resources to carry out the contractual obligations.
The benefits of surety bonds
Surety bonds can be considered a "cost-effective" ways to finance contract security obligations. Unlike banks, a surety provider does not require security like a bank's Letter of Credit and does not need cash or other collateral support. It means more cash flow for a company, reducing debt, and leaving more room for additional contracts that requires security. It represents an alternative with a lower interest rate to a bank guarantees and no utilization or line fees. In short, when there are different types of obligations and parties while managing risk using LOC, surety bonds became a good alternative in lieu. It comes at a cost advantage, leaving borrowing space available for other financial necessities."
How long does a utilization remain valid?
A surety bond will stay valid for the duration of the contract, usually last for a year. It often extended for a maintenance period for another year, after the conclusion of contractual obligations. The maintenance period extended to protect obligees if any problem arises or something needs to be changed or re-done. It also gives principals a time to object claims over concerns or complaints filed by obligees. How to get surety? Insurance brokerages like UW Insure Brokers offer surety services. We provide the choice to bond facilities, advice on wordings, indemnity negotiation, ensuring adequate capacity required.
Technology in the surety space
Modern surety bond transactions are submitted electronically. We have seen contractors required to provide electronic surety documents to procure work. In some jurisdictions worldwide, the digital version of surety bonds is the only acceptable way for bidding. Few companies in Canada offer and deliver an e-bonding platform to facilitate surety bonds' electronic delivery.