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If you’ve ever had to do business in construction, you might be familiar with surety bonds. These are legally binding contracts that guarantee that the principal (the party that has the responsibility of performing the contractual obligation of the bond) will complete the job up to the satisfaction of the Obligee (the party that requires the bond).

In order to understand how a surety bond works, it’s important to know that it is different from an insurance policy. Insurance policies are a way to recover losses in the event of an accident or natural disaster. Surety bonds, however, are a way to transfer risk. They are made to protect the private and public interests that can be harmed by the actions of a third party. In simpler words, a surety bond is an insurance policy that benefits one of the parties, which is paid by the second party and the third party finances it all.

Learn How a Surety Bond Works

  • The Promise

Certain industries require a surety bond, so companies looking to do business within the circle would need to adhere to this regulation. Take for example the business industry. When partnering with another company, the project managers would want to ensure the highest standards of work ethics and performance. In order to make sure their partner company sticks by their promise, they can demand a surety bond.

By adding a surety bond in this business relationship, both parties will have peace of mind. It is also an indication that as long as the partnering company keeps their word and provides efficient services, the bond will remain intact. The bond will soon expire, and the two companies will decide whether to renew it or look for other opportunities. However, the partner company, being the principal, would not get the bond money back. 

  • The Claim

Another scenario is where the partner company fails to meet their obligation. If their performance or completing the work within a set time was a clause in the surety bond, then the project managers can make a claim against their surety bond. If the surety company determines that the partner company was at fault, then they’d pay for the claim to the customer out of the bond. 

Conclusion

These two cases are the most common ones when it comes to understanding how a surety bond works. But this is just one industry where these surety bonds can be used. Another common situation that demands a surety bond is the purchase of a vehicle. There are many situations where surety bond can serve as the perfect insurance. If you too are in one of these situations, make sure you obtain a surety bond to safeguard your business.