In the world of commercial finance, a surety is an insurance policy, sometimes referred to as a bond, that is issued by an insurer or guarantor in behalf of one party. In the context of commercial finance, a surety Bond or guaranty typically involves a formal guarantee by a third party to assume responsibility for a borrower’s debt if that individual defaults on a debt payment. In the case of corporate finance, surety bonds are used as a method of ensuring the payment of funds by a corporation to its investors. Either financial institution can issue a bond, but in the case of a corporation, such bonds must be issued by the board of directors.
Virtually all commercial surety bonds include certain specific characteristics. First, they will include a pledge of the capital stock or equity of the issuing company. Second, they will generally provide for a debt guarantee, which is essentially a promise that the corporation will make the payment of the debt. Third, most bonds will require the submission of certain information and the assurance that certain stipulations will be followed. Finally, and perhaps most importantly, commercial surety bonds will often contain a restrictive covenant’s provision, which authorizes the insurer or guarantor to restrict the issuer from certain acts.
One of the most important purposes of surety bonds is as a device used to protect the rights of the financial institution that issues them. Surety guarantees act as a device that gives the financial institution a legal way to recoup its investment in a given transaction if the venture turns out to be unsuccessful. Surety is often used as a means of ensuring that the investment made by a guarantor is returned in a timely manner.
Commercial surety bonds are used, for example, when a manufacturer needs to provide cover against the risk of product liability in the event that a product is defective and causes harm or injury to a third party. Surety is also frequently used by investors to guarantee that their money invested in a business enterprise will be returned in a timely manner. Likewise, guarantors may use surety bonds as a way to protect themselves should there be any way that the principal is unable to fulfill his/her obligations. One example of this would be the financial guarantee that a principal provides to a lending institution in the event that the company is unable to repay a loan. Surety bonds are also often used as a means of guaranteeing payments by businesses to suppliers.
A surety bond in the context of the business environment is very different from that of a home insurance or automobile insurance contract review. Surety bonds are generally much more expensive than a standard automobile policy, which is why most business owners opt for surety bonds over standard forms of coverage. In the context of the business environment, however, surety bonds are frequently applied to protect against the risk of lawsuits arising from product defects or other claims. For example, an employer may secure insurance protection for his company against claims by an employee who is injured while at work. Without this specific insurance policy, the employer would be responsible for paying the cost of the damages to the employee.
A bond guarantee serves an even greater purpose in the business setting, however. Without surety bonds, businesses would not be able to provide needed short-term financing. As an example, a business owner who has just started a new business venture may need to meet cash requirements in a relatively short period of time. A surety company would provide the necessary short-term financing without the need for a long-term commitment from the principal.
In addition, surety bonds often provide a third party with additional protection in the event that the principal fails to pay his/her obligations. Suppose that the principal defaults on a promissory note, for example. In this situation, the obligor or party that has received the note would have recourse to the laws of contract to recover the principal’s obligation. A surety Bond Company would then represent the obligee and make sure that the agreement is enforceable.
As you can see, the key role that surety plays in the business environment is much more complex than a simple guarantor. Surety ensures that the principal is doing what he/she is supposed to do; but it also serves as a third-party in enforcing any contractual obligations between the principal and the obligee. By requiring the obligee to purchase surety bonds as part of the purchase agreement, the surety company acts as the third-party and fulfills the obligation. However, whether one buys surety bonds on their own or through a surety broker, the fact remains that the principal will need to purchase surety to fulfill the contract. Whether the principal chooses to purchase an existing surety or to form a new account is completely immaterial, because the fact still remains that both require legal obligation to satisfy.