What Is the Meaning of a Surety Bond?

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Surety bonds are a risk mitigation tool issued by insurance companies or specialty surety bonding companies. Surety bonds protect for performance against a contract or contract specifications. The surety company is a third party to a contract, providing payment should the party providing service fail to perform. Surety bonds are most common in the construction industry.

History

  • The oldest known surety document dates to 2750 BC. Corporate surety bonds emerged in the 19th century. In 1894, the U.S. Congress passed a law requiring all federally funded projects to be covered by surety bonds.

Function

  • Surety bonds provide protect against a contractor failing to meet the obligations of a contract. If the contractor was to fail or otherwise fail to complete a project, the surety bond provides compensation to the organization that hired the contractor. This reduces the risk for an organization undertaking a large project.

Types

  • The two most common types of surety bonds are bid bonds and performance bonds. A bid bond is submitted by a contractor with a bid, assuring that the contractor will undertake the project at the quoted price if they win the bid. A performance bond is issued after the bid is awarded. Performance bonds guarantee that the contractor will complete the project to specification. A third type, the payment bond, assures that the contractor will meet all of its payment obligations for the contract.

Benefits

  • Contractors must meet rigorous standards to be issued a surety bond; surety companies will not issue a bond if the contractor is not highly likely to complete the project. Organizations contracting for large projects assume a great deal of risk. Surety bonding helps to reduce that risk by assuring the contractor's performance to the contract specifications.

Misconceptions

  • Surety bonds are sometimes confused with fidelity bonds. While a surety bond assures a company's performance, a fidelity bond protects against dishonest acts by company employees.

References

  • Photo Credit construction image by Pali A from Fotolia.com
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