Surety: Definition, How It Works with Bonds, and Distinctions

What Is Surety?

The surety is the guarantee of the debts of one party by another. A surety is a person or an organization that assumes the responsibility of paying the debt in case the debtor policy defaults or is unable to make the payments. The party that guarantees the debt is referred to as the surety or the guarantor.

A surety is not an insurance policy. The payment made to the surety company is paying for the bond, but the principal is still liable for the debt. The surety is only required to relieve the obligee of the time and resources that will be used to recover any loss or damage from a principal.

A surety is most common in contracts in which one party questions whether the counterparty in the contract will be able to fulfill all requirements. The party may require the counterparty to come forward with a guarantor to reduce risk, with the guarantor entering into a contract of suretyship. This is intended to lower risk to the lender, which might, in turn, lower interest rates for the borrower. A surety can be in the form of a surety bond.

What Is a Surety Bond?

A surety bond is a legally binding contract entered into by three parties: the principal, the obligee, and the surety. The obligee, usually a government entity, requires the principal, typically a business owner or contractor, to obtain a surety bond as a guarantee against future work performance.

The surety is the company that provides a line of credit to guarantee payment of any claim. They provide a financial guarantee to the obligee that the principal will fulfill their obligations. A principal’s obligations could mean complying with state laws and regulations pertaining to a specific business license, or meeting the terms of a construction contract.

If the principal fails to deliver on the terms of the contract entered into with the obligee, then the obligee has the right to file a claim against the bond to recover any damages or losses incurred. If the claim is valid, the surety company will pay reparation that cannot exceed the bond amount. The underwriters will then expect the principal to reimburse them for any claims paid.

Important Surety Distinctions

The claim amount is still retrieved from the principal, either through collateral posted by the principal or through other means.

A surety is not a bank guarantee. Where the surety is liable for any performance risk posed by the principal, the bank guarantee is liable for the financial risk of the contracted project.

The Bottom Line

A surety is a person or party that takes responsibility for the debt, default, or other financial responsibilities of another party. A surety is often used in contracts in which one party’s financial holdings or well-being are in question and the other party wants a guarantor.

Surety bonds are financial instruments that tie the principal, the obligee—often a government entity—and the surety. In the case of surety bonds, the surety is providing a line of credit to the principal so as to reassure the obligee that the principal will fulfill their side of the agreement.