SURETY BONDSSurety bonds guarantee that specific obligations will be fulfilled. The obligation may involve meeting a contractual commitment, paying a debt, or performing certain duties. Usually, a bond is written for a definite amount, which is known as the bond penalty. Each bond is a written contract between three parties. Two of the parties obligate themselves to meet a commitment to the third party. If the commitment is not met, a sum of money, up to but not exceeding the full penalty, becomes payable as damages.
Early forms of suretyship were practiced thousands of years ago. Simple surety arrangements between individuals were made when one person’s personal promise failed to provide another with adequate security.
For example, a creditor might not be willing to lend money to a debtor unless some security was provided by someone else. Centuries ago, the other party was usually a friend or relative, who might place personal property in the hands of the creditor until the debtor repaid the loan. In more extreme cases, the debtor might leave a family member in the custody of the creditor—a practice which did not guarantee repayment of the loan, although it certainly increased incentives to avoid default.
Corporate suretyships were first formed in the 1800s. Prior to that time, individual arrangements were risky and there were no guarantees that the assets of a backer would satisfy the obligation. Once organizations began to specialize in issuing surety bonds, formal contracts backed up by corporate assets became available to meet a wide variety of business and individual needs. Surety bonds are now routinely required by business interests, courts, government bodies, and public agencies as a means of reducing or transferring the risks of transactions and proceedings.Three Parties
A typical surety bond identifies all three parties to the contract and spells out their relationship and obligations. On every bond, the parties are:
• A principal—the party who has agreed to fulfill the obligation, which is the subject of
• An obligee—the party for whose benefit the bond is written. If the principal defaults on the obligation, damages are payable to the obligee.
• A guarantor or surety—the surety providing the bond for a fee. The surety joins with the principal in guaranteeing fulfillment of the obligation, and agrees to pay damages if the principal defaults.