The 3 Types of Surety Bonds Explained
Providing enough assurance is a big part of running a successful business. In some instances, surety bonds are needed so that a guarantee exists for all stakeholders.
Essentially, a surety bond is a legally binding agreement among three parties: the principal, the obligee, and the surety. The surety bond is there to reinforce a promise and that upon the failure to keep this promise, the aggravated party will be compensated.
In this article, we discuss the three types of surety bonds — commercial, contract, and court surety bonds. Along the way, we will also take a look at how surety bonds work.
Let’s get started!
What is a Surety Bond and How Does It Work?
In order for you to understand how surety bonds work, we must first talk about the three parties involved in a surety bond:
- The Principal;
- The Surety; and
- The Obligee.
The principal buys the surety bond. Typically, the principal is a business or professional who reinforces their promise of completing a task within legal bounds and industry regulations. This promise is made to the obligee.
The surety underwrites the surety bond. This entity works in between the principal and the obligee. The surety is the company that prepares the surety bond and takes payment for it from the principal.
It is also the party that guarantees compensation or indemnification for the obligee if a claim is made (e.g. contract breach, illegal practices, fraud, etc.)
The obligee is the individual or entity that is protected by the surety bond. Typically, obligees are clients, investors, project owners, government entities, or beneficiaries. The obligee will be compensated by the surety if the guarantee or promise made by the principal is not fulfilled.
The Three Main Types of Surety Bonds
The main types of surety bonds include contract surety bonds, commercial surety bonds, and court surety bonds. The table below summarizes their key differences:
|Types of Surety Bonds||Purpose||Subtypes|
|Contract Surety Bond||Ensures that a task or payment is completed within the terms of a contract|
|Commercial Surety Bond||Ensures that a professional or business complies with regulations while fulfilling a task or job|
|Court Safety Bond||Either for protecting against the uncertainties of legal action or for protecting the interests of a fiduciary/trustee’s beneficiary|
1. Contract Surety Bonds
First on our list of types of surety bonds are contract surety bonds. These are meant to guarantee that a task is met according to the terms of a signed contract. For this reason, this is a common type of surety bond issued for contractors, construction firms, and other similar businesses.
In such cases, the contractors or construction firms are the principal (or the one making the promise). Meanwhile, the obligee (or the protected party) depends on the type of contract surety bond.
This surety bond guarantees the satisfactory completion of a project by a contractor. These are common for government-related projects (e.g. bridge constructions) and private sector projects (e.g. building construction).
In such cases, the obligees are the project owners, investors, or government entities. If the contractor fails to deliver, the obligee of the performance bond will be compensated.
Just like performance bonds, payment bonds are also common in the construction industry — as well as other similar industries where there are subcontractors and suppliers.
For this type of surety bond, the obligees are the subcontractors and suppliers. They are guaranteed to be paid at a certain time or when the project is completed.
2. Commercial Surety Bonds
Next up on our list of main types of surety bonds are commercial surety bonds. These are surety bonds for businesses and professionals. It is issued to guarantee compliance with legal requirements.
If professionals and businesses show dishonesty or go beyond legal bounds, claims can be filed against them. This will result in a compensation to their obligees.
Typically, the obligees for commercial surety bonds are customers or clients. A few examples of entities that secure commercial surety bonds (as the principal) include brokerage firms, investment advisors, contractors, notaries, and so on.
License and Permit Bonds
Generally, this type of commercial surety bond is required by the government for a specific set of businesses that need to comply with license and permit regulations. In many instances, the businesses required to get this type of surety bond are those that can pose high risks to customers — whether it’s through incompetence, malpractice, fraud, or physical damage.
Businesses that get this kind of surety bond include investment advisors, notaries, liquor retailers, auto dealers, travel agencies, private investigators, and so on.
Unlike license and permit bonds, fidelity bonds are typically not required by the government. Fidelity bonds serve to protect employers from fraudulent/dishonest actions by employees. For this surety bond, the obligee is the employer and employees are the principals.
Fidelity bonds are commonly required in insurance companies, banks, and brokerage firms.
3. Court Surety Bonds
The two main purposes of court surety bonds is to minimize financial loss for a person pursuing legal action and to ensure that court-appointed tasks (for fiduciaries/trustees) are fulfilled. This is why court surety bonds are subdivided into judicial bonds and fiduciary bonds.
This is the type of court surety bond that helps to limit losses arising from a judicial ruling. Judicial bonds are further subdivided into bail bonds, appeal bonds, and plaintiff’s-attachment bonds.
This type of court surety bond ensures that a court-ordered task for a fiduciary/trustee is fulfilled. A fiduciary is an individual or entity acting on behalf of someone else. They are legally bound to act in the other person’s best interests.
As such, fiduciary bonds are further subdivided into guardianship bonds, executor bonds, and custodian bonds.
Get Surety Bonds That You Can Count On
Contractors Insurance is an Ontario-based, award-winning insurance brokerage firm. On top of customized insurance for businesses and professionals, we also specialize in setting up surety bonds tailored to your needs.
If you’re still not sure which type of surety bond your business needs, our team of dedicated professionals is here to give you insights and recommendations.
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