What is a Surety Bond?
A Surety Bond is a financial guarantee between parties of a contract, with the aim to deliver pre-obligated conditions stipulated under at the agreement at a future date. The obligee (tender party that awards the contract) would want some assurance that the principal (contracted party) would be able to complete the project in time, hence they would require the principal to secure a Surety Bond from the Surety (in this case an insurance company) as protection. In any event that the principal fails to meet conditions stated in the contract, the obligee is entitled to claim damages from the Surety for losses associated with performance failure on the part of the principal.
Surety bonds are commonly used as an alternative to bank guarantees, provided the obligee is acceptable to its use. Securing a bank guarantee typically requires the principal to pledge collaterals such as stocks, time deposits, cash and/or personal or corporate director’s guarantees in exchange for its issuance. Cash collaterals are often dollar for dollar for the bank guarantee value, meaning to raise a bank guarantee for $500,000, the principal would have to pledge a cash deposit of an equivalent $500,000 with the bank. Premiums charged for a surety bond is a fraction of the bond value, hence businesses often turn to the insurance market for solutions in order to fulfil the project requirement.