Surety bonds are very important for all kinds of businesses. However, very few business owners are aware of their benefits or even how they work. The main purpose of a surety bond is to provide extra protection to all the parties involved in a business arrangement. Many think that surety bonds are just another form of insurance but there are some key differences. In order to understand how your business could benefit from implementing surety bonds, you must first understand their key features and functions and the unique protective role they can play in multi-party business deals. (Image Credit: Tookapic/Pixabay)
This article is a guide to how surety bonds work and how they can benefit your business.
The Four Types of Surety Bonds
The most commonly implemented type of surety bonds which can benefit all businesses are known as contract bonds. There are four distinct types of contract bonds: performance bonds, bid bonds, payment bonds and maintenance bonds. Each type offers a different function.
How do the four types work?
Performance bonds ensure that a hired individual or contractor completes the work to the standards and conditions laid out in their contract. There are various applications of performance bonds. You can browse here to learn about some real-life situations where they are useful. Essentially, performance bonds are valuable to businesses because they ensure that work you have paid for is completed. Moreover, it assures that the entity you hired is not able to break the agreement without penalty. This is guaranteed by a third party called the “surety,” who will pay you the money and then go after the contractor to get it back.
Bid bonds ensure that when a principal bids for a contract, awardees are financially obliged to pay what they owe. For example, let us suppose your business has a big construction project and with three firms bidding for it. If the firm that you awarded the contract to doesn’t pay, you will have lost the opportunity with the other two firms. It also ensures that any contractors which the firm has hired to do the work get paid and don’t also pass on other opportunities.
Payment bonds ensure there are no outstanding costs left at the end of a project which will be left to a contractor to pay. If your business is a construction company and the firm that hired you refuses to pay, this bond protects you financially. Here, the third-party surety will pay you what is owed and then go after the firm that hired you.
With maintenance bonds, a contractor must return and do any repairs that are required or to pay for these repairs. This prevents a contractor from starting a new job, getting the bulk of the payment and then shirking on the rest of the project. The surety will pay the money needed for the repairs or to finish the project. They then chase up the contractor for the money.
The Three Parties Involved
Surety bonds and traditional insurance bonds have one primary difference. Simply, surety bonds involve three parties rather than two.
The principal is the party in the agreement who is obligated to perform the task agreed upon in the bond contract.
The obligee is the party who receives the fruits of the task that the principal is obligated to perform.
The surety is the third party who guarantees both the principal and the obligee that the other party will fulfill their side of the arrangement.
How It Works
There is obviously an accepted level of risk in any arrangement your business enters into with another party. But a surety bond helps to minimize that risk. A surety protects both the obligee and the principal. Of course, there are various situations where your business could be either one of these two parties. If the principal or the obligee fails to perform an agreed-upon payment or task, the surety will cover the expenses. Then they will take the required steps to get the money back from the other party, plus extra fees. These may include court costs, lawyers fees and other expenses which can be significantly higher than the original money owed.
Surety bonds are very useful for every kind of business as they provide peace of mind. Whether you have a small family business or a major international company, it is important to minimize the risks involved in a business deal. Speak to a surety bond expert and find out which kind of bond is best for you.