Overview of Surety Law

A surety is a legal agreement that guarantees the debts or obligations of another party. Surety bonds are three-party agreements between the:

1. Principal: Party that needs the surety bond
2. Obligee: Party that requires the surety bond
3. Surety: Party that provides the surety bond

The principal has a contractual agreement with the obligee to perform certain actions — for example, construct a house. The surety provides a bond to the obligee guaranteeing the principal’s performance. The surety provides an indemnification guarantee to the obligee if the principal defaults on their obligation.

Surety bonds are common in the construction industry to guarantee the work of subcontractors. Under the Miller Act, most federal construction projects require a surety payment bond to guarantee performance. Surety law can vary by state law and industry. For more information, talk to a local surety law attorney.

What Is a Surety Agreement?

In a surety agreement, the surety assumes the responsibility of a principal to fulfill their contractual obligations. Some financial agreements, government agency contracts, or real estate deals require a surety to guarantee financial risk or project completion.

Surety bonds are a risk management tool, like an insurance policy. Insurance and sureties offer a guarantee against financial risks. However, insurance policies are only an agreement between two parties. A surety bond is a third-party guarantee for financial protection.

There are various types of surety bonds, depending on the industry and suretyship agreement. The most common types of surety agreements include contract bonds and commercial surety bonds. Other types include court surety and fidelity surety bonds.

Contract surety bonds guarantee contract terms, which can include performance bonds, maintenance bonds, and subdivision bonds. Contract bonds are common in construction industry.

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The Three Parties in a Surety Relationship

There are three parties in a surety relationship: The surety, the obligee, and the principal. Each party owes a duty to the other and each are parties to the surety bond.

If the principal cannot pay the debt or obligation, the surety assumes liability. The obligee can file a claim against the surety to recover any damages or financial losses. The surety can then file a claim against the principal for reimbursement.

For example, say a construction project involves building a new hospital. The general contractor (obligee) has a contract with a subcontractor (principal) to install the windows of the hospital. The project owner has not worked with the subcontractor before and wants a financial guarantee they will perform on time.

A surety company or insurance company (the surety) guarantees the subcontractor’s performance according to the construction contract. If the subcontractor fails to fulfill their contractual obligations, the surety bond covers the financial costs of non-performance and reimbursement for getting the work done by another window company.

Parties can make modifications to the surety bond but any modifications generally require consent of all three parties. Parties can also modify the surety terms with an endorsement or surety bond rider.

Understanding Your Obligations as a Surety

A surety assumes the financial liability of the principal if they fail to perform under their agreement with the obligee. The surety bond guarantees against losses up to a maximum surety limit.

A surety is like a co-signer on a car loan. The co-signer is not buying the vehicle from the from the dealership. However, the co-signer agrees to cover the financial costs if the borrower defaults on the loan.

A bail bond is another example of a surety agreement. The court requires a bond to release the defendant pending their court appearance. A bail bond company acts as the surety to guarantee the defendant’s appearance in court. If the defendant fails to show up in court, the bail bond company has to pay the court for the defendant’s failure to appear.

As the surety, you have a financial obligation to cover the costs of the principal’s non-performance. The financial penalties may include losses for delays, replacement costs, and lost profits. The financial risk depends on the type of surety bond and the individual situation.

Know Your Rights Before Entering Into a Surety Bond

Insurance companies closely review financial and performance records before entering into a surety agreement. The surety must understand the financial risks involved if the principal fails to perform. If the principal fails to perform, the surety assumes all the financial liability of their non-performance, including costs for delays, higher performance costs, and contractual penalties.

Make sure you understand your legal rights and financial risks before signing onto a surety bond. A surety lawyer can explain your legal rights and obligations. A surety lawyer can also help you negotiate to balance the risk of the surety agreement with your compensation. Talk to a local surety law attorney for legal advice about surety bond agreements.