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What Are Insurance Bonds and How Do They Work?

Surety bonds are widely misunderstood, and there are so many construction companies who are unaware of how helpful they can be in agreement with a contractor or customer. Surety bonds provide a unique level of protection to both parties involved in a construction contract that doesn’t exist in other kinds of contracts. There are so many cases of bad actors when it comes to the construction industry that any extra security in a deal is greatly appreciated by everyone who has signed it.

To help people working in the construction industry understand the benefits that surety bonds can provide, this is a guide to how surety bonds work and the advantages which they can bring.

Surety Bonds Explained

Any business agreement, not just those in the construction, carries a certain amount of risk as all the parties involved are relying to some extent on the other parties’ staying true to their word and delivering on their side of the arrangement. Unfortunately, there are far too many cases, particularly in the construction industry, where cowboy tradesmen do a shoddy or incomplete job, or the party who hires a contractor fails to pay them. What a surety bond provides is an impartial third party, which ensures that the other parties in the contract do not duck out on their responsibilities. If they do, the surety compensates the injured party and then has the expertise and authority to hold the responsible party to account. In order to understand how this process works, you must first understand the role of each of the three parties in a surety bond to see where your business would fit in.

The Three Parties 

The first party in a surety bond, and the one which is unique to this kind of arrangement, is called the surety. They ensure that the other two parties fulfill their obligations as agreed in the contract. They do this by holding any party which doesn’t fulfill their obligations financially and legally responsible. This is vital in construction where huge sums of money and jobs are on the line.

The first of the two parties which the surety protects is the principal. They are the party that pays for a certain construction service to be performed. An easy example which we can use is that of a big construction company hiring an electrician to do the wiring in a house. The second party, which is protected by the surety, is called the obligee. This is the party that is being paid to provide the construction service. In our example, the obligee would be the electrician.

The Four Different Surety Bonds 

The four surety bonds that are used in construction contracts are performance bonds, bid bonds, payment bonds, and maintenance bonds. In each, the two main parties have different responsibilities, which are guaranteed by the surety. This is how they work in practice:

1. Performance Bonds

In a performance bond, the surety guarantees that the obligee does the work which the principal has paid them for to the exact specifications of the contract, which they have signed. The experts at SwiftBonds.com explain that if they do not, the surety will pay the principal the money they need to hire somebody else. After that, the surety will take the obligee to court for the money plus an additional sum to pay the surety for the service.

2. Payment Bonds

In a payment bond, the surety guarantees that if the obligee does the work which the principal has paid them to do, the principal pays them the money, which was agreed. If they do not, the surety will pay the obligee the outstanding money they are owed. After that, the surety will take the principal to court for the money, again with an additional sum to pay the surety for the service.

3. Maintenance Bonds

In a maintenance bond, the surety guarantees that the obligee returns to do any repairs or adjustments which are needed. If they do not, the surety will pay the principal the money they need to hire somebody else for these improvements. After that, the surety will take the obligee to court for the money with significant extra charges.

4. Bid Bonds

In a bid bond, the surety guarantees that any company which makes a bid to work on a construction project has the means to complete it as stated in the contract. If they fail to do so, the surety will then compensate the party that hired the company and then seek compensation and additional money from that company.

There are so many different applications of surety bonds that everyone involved in construction should learn about their benefits. Before you enter into any kind of arrangement with another party, speak to a surety bonds expert to see what extra protection you can get.

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Written by Jordan

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