Surety Bond
A three-party guarantee in which a surety company promises to fulfill an obligation if the principal fails to do so.
What is Surety Bond?
A surety bond is a legally binding agreement among three parties: the principal (the party required to perform an obligation), the obligee (the party requiring the guarantee), and the surety (the insurance or bonding company that backs the guarantee). If the principal fails to meet their obligation, the surety steps in to compensate the obligee — and then typically seeks reimbursement from the principal. Unlike most insurance, surety bonds are not designed to absorb losses permanently; they function as a form of credit. Common types include contract surety bonds (bid, performance, and payment bonds required in construction), commercial surety bonds (license and permit bonds required by government agencies), and court bonds.
Example
A city government requires construction contractors to post a $2 million performance bond before beginning work on a municipal building. When the contractor defaults midway through the project, the city files a claim with the surety company, which funds a replacement contractor to complete the work. The surety then pursues the defaulting contractor for the $1.4 million it paid out to finish the job.