There’s a certain degree of mutual trust and confidence that comes with every business dealing. All sides of a business agreement, in theory, bank on each other’s integrity and ability to live up to their end of the deal to ensure a successful transaction or the proper fulfilment of an obligation.
Unfortunately, word of mouth and even agreements on paper can only take you so far. What happens when one party is unable to deliver on the terms of the contract? That’s where surety bonds come in.
What is a surety bond?
A surety bond, also known as a contract of suretyship, is a legally binding promise to pay one party a corresponding amount of money in case a second party is unable to meet a particular obligation under law or contract. A surety bond guarantees that a contract will be completed successfully by imposing a penalty on non-compliance.
There are three (3) parties involved in a surety bond:
The first party is called the principal or obligor. The principal is the party responsible for delivering a service, performing an act, or fulfilling the terms of the contract. An example would be a developer.
The second party is the obligee or beneficiary. The obligee is the party to whom the principal must deliver the service or product,and is thus the party in whose favor the bond is issued. According to law, the obligee can be a creditor or lessee a project owner among others.
The third party is the surety or insurer. Basically, the surety is the party that issues the bond on the principal’s behalf. As such, the surety is effectively responsible for ensuring that the principal fulfils their side of the agreement.
Basically, the surety bond is designed to safeguard the obligee from any losses, in the event that the principal is unable to deliver upon their agreement.
Differences between insurance contracts and contracts of suretyship
While both contracts are designed to give some form of compensation to at least one party, they differ in a number of significant ways.
- While an insurance contract covers loss, a contract of surety guarantees the delivery of service.
- An insurance contract is a principal contract; on the other hand, a contract of surety is an accessory contract, meaning it cannot exist without a principal obligation that requires it.
- An insurance contract only involves two (2) parties: The insurer and the insured.
- A contract of suretyship entitles a reimbursement from the principal and their guarantors for losses incurred under contract.
- A contract of suretyship requires collateral or guarantors from the principal; an insurance contract does not.
- An insurance contract may be cancelledby either the property owner or the insurance company; meanwhile, only the obligee’s consent enables the surety to cancel the contract of suretyship.
- While an insurance contract’s validity period is one (1) year by default, a contract of suretyship’s duration depends on the terms of the contract.
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