Understanding the Purpose of Surety Bonds

There are so many businesses and individuals who could benefit from surety bonds and yet their purpose is still widely misunderstood. Surety bonds provide protection and certain assurances to contracts between two parties. These protections and securities don’t exist in any other type of contract so they are hugely important. In order to understand the purpose of surety bonds and the situations in which they can be applied, you must first understand the differences between the four main types of bonds.

To explain these differences and everything else you need to know, here is a guide to understanding the purpose of surety bonds.

Understanding the Purpose of Surety Bonds

Which Surety Bonds Are Most Commonly Used?

There are various surety bonds that can be used to secure arrangements but the most commonly used are called contract bonds. As their name suggests, contract bonds are put in place to protect the two sides in a contractual agreement, and the folks at Swiftbonds explain that there are four main types of contract bonds, each with a different purpose. These are bonds for performance, maintenance, payments, and bids. 

The Purpose of the Four Types of Contract Bonds

All four contract bonds are designed to protect each of the two main parties in a contract. These two main parties are called the principal and the obligee. The principal is usually the party who hires a contractor and the obligee is the contractor who is hired. Essentially, if the principal or the obligee does not meet the terms of the agreement, the injured party is compensated in some way. Contract bonds are mainly used in the construction and trade industries where contractors and sub-contractors are hired to do a specific job.

Here are the main differences between the four types of bond:

Performance Bonds

Performance bonds ensure that the obligee completes the work to the standard which has been agreed with the principal in the contract. This protects the principal from the obligee doing a shoddy job. There are many so-called “cowboy tradespeople” who make promises they then fail to keep, but performance bonds are designed to ensure the quality of the work. Many different kinds of contractors can be bound by performance bonds such as roofers, plumbers, and even entire construction companies.

Maintenance Bonds

Maintenance bonds are designed with a similar purpose to performance bonds. They protect the principal from the obligee doing a bad job and then refusing to come back and do any necessary improvements or repairs to get it up to scratch. This is important because it means the principal won’t need to put themselves over budget hiring another contractor to come and do the necessary work which the original contractor is refusing to do.

Payment Bonds

Payment bonds protect the obligee from the principal refusing to pay them even though they have done everything they were contracted to do. Essentially, payment bonds are the opposite of performance and maintenance bonds. The obligee fulfilled their side of the arrangement and so the principal should pay them as agreed. Payment bonds are very important because taking the principal to court for the money can be very expensive and time-consuming for the obligee and may interrupt their business or lives.

Bid Bonds

When a project is made available for contractors to make a bid on, the winning contractor is bound by a bid bond to do the job they said they would do for the price they offered. If they fail to do so, the principal will receive the difference between that price and the next lowest price which was bid by another contractor.  

How a Surety Bond Is Upheld

As well as the principal and obligee, a surety bond has an impartial third party which ensures the contract’s terms are met. This party is called a surety and they have legal powers to hold the other two parties accountable for breaching the agreement. If a contractor does a poor job despite being bound by a performance or maintenance bond, for example, the principal will be given the money they need to fix the issues, and the surety will then take legal steps against the obligee. 

On the other hand, if the contractor has done everything according to the arrangement but the principal refuses to pay them all or part of the money, the surety will pay them instead, and will then go after the principal for the money plus other penalties.

Understanding the Purpose of Surety Bonds

Surety bonds are so useful in a huge number of different contracts and business arrangements. They can protect you when you hire a contractor to do some work for you and contrastingly can provide protections if you are the contractor. Surety bonds can help to guarantee performance, payments and ensure that everyone honors the agreement.

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