A surety is when one party (the surety) promises to assume the debts or performance responsibility of another party (principal) when he defaults. This is a guarantee or security that they will be liable and the other party will not incur losses and damages when the principal defaults. The surety becomes legally bound or liable for the debts and obligations of the principal.
A surety bond is a contract between three parties the principal, the surety and the obligee which protects the obligee if the principal fails to meet his part of the contract. The principal has a duty towards the obligee but when the principal defaults the surety pays the obligee. The principal pays an annual premium to the surety which is usually an insurance company for a guaranteed amount which is to be paid in case of default. Surety bonds are sold by agents and brokers who are licensed, on behalf of the insurance company. The maximum limit to be paid and the premium are set in advance. State insurance commissioners regulate the bonds.
The surety can be an individual or an insurance company. The surety ensures the people/company/government entering into the contract that it will pay them when the principal fails to meet their obligation. The surety bond is a protection to the person so that he will not incur losses when the principal fails to honor their part of the agreement. The premium is a guaranteed amount to be paid in case of default. This reduces the risk the person entering into the contract might be exposed to. When it is a lender the surety reduces the borrower's risk. This makes the borrower to be favorable terms like a lower interest rate.
A surety bond is entered when there is question of the principal fulfilling their duty or when it is in the best interests of the public who need to be protected from possible failure of the person or organizations, when they do not fulfill their debt or performance and completion obligations.
Before issuing licenses and permits, the government requires license and permit bonds from a surety as a guarantee that the principal company will comply with the set laws, statutes and regulations in their operations. Some businesses are required to have surety bonds before they are issued with licenses and permits. Many businesses, contractors, motor vehicle dealers, health spas, money transmitters and others are required to comply with the relevant laws and taxes. The government agrees to issue the licenses when a surety bond is signed.
A contractor can enter into performance and payment surety so that when he fails to perform his duties or make payments to suppliers and sub-contractors the surety can perform these duties and pay on his behalf. When the person or organization fails to fulfill their obligation, the surety will check the claim and if it is valid, pay the claim and seek reimbursement from the person or organization who has defaulted in addition to other fees incurred.