Definition of a Surety Agreement

by Tim McMahon - Updated September 26, 2017
A surety agreement is a contract by a third party to cover the obligations of another.

A "surety" is a contract or agreement where one person guarantees the debts of another. Often they are called surety bonds or surety agreements. Surety bonds commonly are used to protect the government from the misconduct or failure of a company to fulfill its obligations. For example, a contractor building something for the government might be required to purchase a surety bond to reimburse the government if the project isn't completed on time or up to the required standards.

Parties

There are three parties to a surety agreement. The first party is called the "principal" who is the person (or company) purchasing the surety agreement. The principal has some sort of obligation and is basically purchasing a guarantee that the obligation to the second party (called the "obligee") will be met. The third party is the "guarantor," and this is generally a surety bond company that is assuming the risk of collecting from the principal, should the principal fail to meet his obligation to the obligee.

Legalities

For a surety obligation to exist legally the guarantor must have received some form of payment or "consideration." All people in the contract must be legally able to enter into binding contracts. The obligation of the guarantor cannot be greater than the original obligation of the principal, although it can be less than the original obligation. The obligation of the guarantor ends when the terms of the contract are fulfilled by the principal or some other terms of the contract are met.

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What If the Principal Fails

If the principal fails to meet his obligations and the surety bond company has to reimburse the obligee, the surety company will seek reimbursement from the principal. Surety agreements are not insurance. The payment made to the surety company is payment for the bond, but the principal is still liable for the debt. The primary purpose of the surety company is to relieve the obligee of the time and inconvenience of collecting from the principal. The obligee instead collects immediately from the guarantor, and then the guarantor must collect the obligation from the principal either through collateral posted by the principal or through other means.

Types of Surety Bonds

There are a variety of types of surety bonds or agreements. The first type is called a license or permit surety bond, and it guarantees that a professional such as a mortgage broker, insurance agent or car dealer obeys the laws regarding the performance of its duty. Similarly, public officials can be bonded regarding their performance. There are also surety bonds to protect against employee dishonesty or guarantee that people who handle other people's money fulfill their fiduciary responsibility. People who appear before the court can be bonded. And finally there are bonds related to construction such as bid bonds, payment bonds, performance bonds, etc.

About the Author

Tim McMahon began publishing the "Moore Inflation Predictor" and "Financial Trend Forecaster" newsletter in 1995 and has published it every month since. He is also the editor of InflationData.com and the author of "Healthy Tongue Secrets," a book on dealing with problems like thrush and geographic tongue. He holds a Bachelor of Science in engineering management from Clarkson University.

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