A surety bond is a three-party agreement between the principal, the surety, and the obligee. Surety
bonds can be required for various reasons such as to start a business, obtain a license, take on construction projects or to fulfill a court order. States and municipalities may have varying requirements when it comes to surety bonding. Essentially, a surety bond protects the obligee in the event of the principal’s failure to meet a specified obligation.
The parties of a surety bond:
The principal: The principal is the one who is required to obtain a bond to satisfy a certain requirement. Depending on the size of the bond, the principal’s credit and financial history will be evaluated to determine if the principal qualifies for the bond. These financial factors will also have an impact on the price that the principal is quoted for the bond. The fact that a principal may have poor credit does not disqualify them from being eligible for a bond. The principal may be able to provide collateral in order to obtain the bond.
The surety: The surety is the insurance company that will be providing the bond to the principal to satisfy the requirement of the obligee. If it has been determined that the principal defaults on their obligation(s) to the obligee, the surety will be required to pay the claim on the bond. The surety company will look to be made whole by the principal in the event of default. The surety may also be referred to some as the “obligor”. Principals can look up the licensing status of surety companies using resources such as the NAIC website.
The obligee: The obligee is the party that is requiring the bond. Often times, the obligee is a governmental entity. The obligee requires bonds so that in the event of non-performance, the citizens of that state or municipality are protected.
A real life example:
For example, the Florida Department of Highway Safety and Motor Vehicles (obligee) requires that all businesses (principals) who wish to sell mobile homes in Florida obtain a bond from an admitted insurance carrier (surety). In this case, each business must file a bond with the obligee in the amount of $25,000 to activate their licenses. While the penal sum of the bond is $25,000, a bond of this nature typically costs between $250-$2,000 depending on the credit and financial history of the principal. This is just one of the tens of thousands of bonds that can be required by various obligees across the country. Suretypedia.com contains a listing of over 10,000 bond forms required by different states and municipalities.
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