When a business gets into a contract, there is always something that has to be satisfied for a contract to be deemed completed. This translates to every industry where fulfilling an obligation will mean that one is released from a contract. So, what happens when a party fails to deliver on their promise? This is where reassuring deals come into play, such as surety bonds.
What are surety bonds?
This is a type of agreement that will be established between three independent parties. The ones involved are divided into those who perform a service, those who receive it, and those who guarantee that the service will be performed. Professional names of these entities within the contract are, respectively, the principal, obligee, and surety. The main purpose is to protect parties who have paid for a service to be delivered, by ensuring that the other participant reasonably performs as per the written compromise.
The construction industry
A common market for surety bonds is within the construction circles. Since the majority of the projects are based on a hefty initial investment, people are looking to get protected against any breach. What drives the popularity of these bonds is the nature of the construction industry. There are countless issues that could arise over the course of a project which could all defer or terminate the process.
Sometimes, construction companies will have more than one surety bond on large endeavors. Besides signing an overall surety that guarantees the final completion (where the construction company would be the principal), they can also sign bonds where they are the obligee and someone else owes them a service. This happens with suppliers, distributors, or independent contracts who are then legally obligated to do their smaller tasks. For example, by ensuring that the supply materials are delivered on time, the construction company will have better chances of not violating their surety.
Obtaining a surety bond
When a company makes a final decision to get a surety bond, insurance institutions come into play. These businesses charge an interest rate based on the credit-worthiness of the principal. If the construction company has a 50% incompletion rate, they will be a subject to enormous interest on their surety. This is why the name of the contract carries a “bond” part to it. The applicant’s credit history is analyzed in depth, and their previous endeavors will determine how much needs to be paid for an insurance provider to back them up. The rate usually varies anywhere from 1% for very successful companies all the way to 15% for those with questionable spending history.
A safe way to build
Surety bonds are already considered mandatory in all governmental building contracts. They are becoming more popular due to the safety that they provide the investor with. In case a company is insolvent and cannot complete the building process, one will get their invested capital back. This is why that interest cost is outweighed by the potential benefits.