While many independent contractors and entrepreneurs are familiar non-compete agreements and their benefits, fewer are aware of surety bonds and their importance. A surety bond is a legally binding contract between three parties that ensures that specific obligations are met between the parties. In other words, the first party involved (the surety) guarantees to pay the second party, (the obligee) an agreed upon amount of money if the third party (principal) doesn’t do what is required and agreed upon. The surety protects against some monetary loss and in some ways can be viewed as insurance.
These types of bonds are typically issued by banks or companies specializing in surety bonds. The financial strength and solvency of the institution issuing the surety bond is usually verified by various means, such as government and private audits. The principal in the contract, that is, the person performing the work and meeting the contractual obligation pays the surety company a premium for their financial backing. When creating a surety bond, all parties agree upon the ‘penal sum’ of the bond, which is the maximum amount of money that the surety is required to pay the obligee if the principal fails to meet the specified obligations.
Two types of surety bonds that independent contractors commonly use are bid bonds and performance bonds. A bid bond financially protects the obligee in the case that a principal is awarded a contract but fails to sign the contract or provide payment bonds. These types of bonds also help in the screening process of contractors by eliminating unqualified bidders because they show the project owner that the contractor can comply with the bid contract.
A performance bond protects the project owner from loss in case the contractor fails to complete the contract or completes it in a way that does now match the terms and conditions set beforehand.