What Is a Surety Bond and Why Does it Matter?

Businesses in many industries rely on surety bonds to establish credibility, meet contract requirements, and manage risks. These surety bonds protect stakeholders from financial losses if a business fails to meet its contractual obligations, but their benefits go beyond this.

In this article, we’ll break down what surety bonds are, how they work, and why every business needs them.

What is a Surety Bond in Canada?

A surety bond is a three-party agreement consisting of the principal (the business working on a project), the obligee (the project owner), and the surety (the company providing the bond). This agreement protects the obligee in the case of the principal’s failure to deliver on their obligations. If the principal doesn’t stick to the timeline, abandons the work, or fails to meet quality standards, the surety company ensures the obligee is compensated or the project is completed by another qualified party.

A surety bond’s meaning lies in its role as a legal agreement that protects project owners against financial risk. Besides the protection it provides to stakeholders, it also enhances your business’s credibility and helps you qualify for huge projects that might otherwise be out of reach.

What is a Surety Company?

Surety bonding companies are specialized firms that provide bonding solutions to businesses, contractors, and professionals who need to demonstrate financial responsibility. Before providing a surety bond to anyone, surety companies assess applicants thoroughly to ensure their eligibility for a bond. They usually assess the following:

The applicant’s financial strength and credit history
Experience and history of completing similar projects
Business operations and reputation
Capacity to fulfill contractual obligations

This process helps surety companies determine whether the applicant is eligible to obtain surety bonds, the premium they will pay, and the limit they’re qualified for.

How Does a Surety Bond Work?

A surety bond works by providing financial protection to the obligee (the project owner) if the principal (the business or contractor) defaults on their obligations. In this case, the surety either steps in to cover the losses or arranges for the project to be completed by another qualified party.

The three parties involved in this agreement are:

The Principal: This party is the business or the contractor working on a project, and is obligated to fulfill the terms of a contract or a legal agreement. If the principal doesn’t deliver the project as promised, the obligee can file a claim against the bond. Although the surety will compensate the obligee for the loss, the principal remains responsible for reimbursing the surety for any payments made.
The Obligee: This is the project owner who requires the bond to ensure protection against financial loss. It could be a private corporation, a government agency, or a project manager wanting assurance that work will be completed as promised.
The Surety: This party is the firm or insurance company that issues the bond. It guarantees that the project will be delivered as promised by the principal or that compensation will be provided to the obligee if the principal fails to meet their obligations. If you’re looking for the best surety bond insurance company in Canada, you’re in the right place. Contact St. Andrews today to learn more about our surety bonding solution and secure the bonds you need in Canada.

What Are the Types of Surety Bonds?

There are several types of surety bonds in Canada; the most common ones are contract bonds, commercial bonds, and fidelity bonds. Each type of these bonds serves a different purpose and protects against specific risks.

Below is a breakdown of each type of surety bond and how it works:

Contract Surety Bonds

Contact bonds are primarily used in the construction industry to ensure that contractors fulfill their obligations to the project owner, subcontractors, or suppliers. These bonds guarantee the contractor will complete the project as agreed and pay the parties involved in the project.

Contractors in Canada need the following contract surety bonds:

Bid Bonds: If a contractor’s bid is chosen, this bid ensures that he enters the construction contract at the bid price and provides the necessary performance and payment bonds as required by the project owner.
Performance Bonds: This type of surety bond guarantees performance by ensuring the contractor completes the project in accordance with the contract’s specifications, timeline, and quality requirements. If the contractor (the principal) defaults, the surety steps in to compensate the project owner or arranges for the project to be completed by another qualified partner.
Material and Payment Bonds: Construction projects usually have several parties involved. This bond guarantees payment for the suppliers, subcontractors, and other parties involved in the project.
Maintenance Bonds: This type of surety bond insures the project owner for a certain period of time in case any defects or faults arise after the project is completed. During this warranty period, the contractor will be responsible for fixing the issues or compensating the project owner for any financial loss.
Supply Bonds: Supply bonds are typically required in large projects. It ensures the supplier will deliver the required material for the project on time and as specified in the agreement.

Commercial Surety Bonds

Commercial surety bonds are needed in Canada to meet licensing, regulatory, and security requirements. They assure that businesses will operate in compliance with laws, and they may also be required to uphold a municipal ordinance established by a city or town.

Examples of commercial surety bonds that are required by the government or by other entities include:

License and Permit Bonds: These surety bonds provide assurance that a business will comply with licensing laws, regulations, and industry standards. If the principal fails to follow these rules, the surety compensates the government agency for any financial loss.
Customs Bonds: If you have a company that imports goods into Canada, a customs bond ensures payment of duties, taxes, and other fees to the government.
Court Bonds: Court bonds are usually legally obligated by the federal government, provincial courts, or other legal authorities to ensure companies or individuals fulfill their legal responsibilities. Examples of court bonds are judicial bonds and fiduciary bonds, which guarantee that parties involved in legal proceedings are acting in good faith and complying with court orders.
Tax Bonds: Tax bonds are required for particular businesses, usually those dealing with regulated goods, including alcohol and tobacco. These bonds ensure that businesses pay all taxes and fees owed to government authorities on time.
Public Official Bonds: These bonds guarantee that elected or appointed public officials will perform their duties faithfully. They provide a particular privilege to taxpayers and government agencies by protecting them from financial loss caused by misconduct, negligence, or failure to comply with laws.
Warehouse Bonds: These bonds guarantee that operators will store products safely and comply with all licensing and security requirements. If a second party is harmed due to a failure to meet these obligations, the surety compensates this party to cover the loss.

Fidelity Bonds

While contract bonds and commercial bonds protect the obligee, fidelity bonds protect the business itself from losses caused by theft, fraud, or employee dishonesty. Many people may confuse insurance with surety bonds, especially fidelity bonds, but they aren’t the same. Some fidelity surety bond examples are:

Employee Dishonesty Bonds: protect businesses against illegal actions committed by employees, such as fraud, theft, or forgery.
Business Service Bonds: Protect clients against theft, fraud, or other dishonest acts committed by employees while performing services on the client’s property.

Miscellaneous Bonds

A surety bond, by definition, is an agreement between three parties: the principal, the obligee, and the surety. Miscellaneous bonds still fall under this definition, but they aren’t classified under other bond types and are used for specialized obligations. They are designed to provide protection in one-of-a-kind situations, such as guaranteeing payment of utility bills or covering fuel tax obligations.

At St. Andrews, we have access to a broad range of surety bond producers who partner with us to deliver the best surety bonding solutions for your business. Contact us today to secure the bonds you need.

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What Is the Difference Between Surety Bonds and Bank Guarantees?

The main differences between surety bonds and bank guarantees are:

Issuing Party: Surety bonds are issued by surety companies, and bank guarantees are issued by banks or other financial institutions.
Parties Involved: A surety bond is a three-party agreement between a principal, an obligee, and the surety. Meanwhile, a bank guarantee is a two-party agreement between the bank and the beneficiary.
Purpose: Surety bonds are for several purposes, including guaranteeing faithful performance, payment to subcontractors and suppliers, and meeting regulatory requirements. They are required from general contractors working on projects for government agencies or private owners. On the other hand, bank guarantees are used to provide direct financial protection to the beneficiary to compensate in case the contractor fails to meet their financial or contractual obligations.
Accountability: When a contractor buys a surety bond, he remains fully accountable for the contract. If he defaults, the surety pays the obligee up to the bond amount, but the contractor has to reimburse the surety. In legal cases, a court may require a bond to protect an opposing litigant or to ensure a public official performs their duties. In a bank guarantee, the bank assumes direct responsibility to pay the beneficiary, which directly affects the contractor’s available credit.

What Is the Purpose of a Surety?

A surety bond or a security bond is all about assuring the obligee that the principal will fulfill their contractual and legal obligations as specified in the agreement. The surety industry plays a vital role in protecting private project owners, government bodies, municipal governments, and the public from financial losses caused by contractor default or non-compliance. Besides protecting the obligee, surety bonds also provide a competitive edge to contractors by enhancing their reputation and demonstrating financial stability to project owners and potential clients.

What is a Surety Limit?

A surety limit is the maximum bond amount that a surety company assigns for a principal based on their experience, credit score, and risk profile. In other words, it sets a financial cap on the amount the surety is willing to pay in case the principal defaults on their obligations. Before setting this limit, the principal is usually required to sign an indemnity agreement to protect the surety and guarantee that the principal will reimburse any amounts paid by the surety on a valid claim.

What Are the Benefits of Buying Surety Bonds?

The top advantages of buying surety bonds in Canada are:

Unlike what many people think, surety bonds aren’t only beneficial for one party, as they also benefit the principal by enhancing their reputation and credibility. This allows the principal to take on bigger projects and stand out in the construction competitive landscape.
Surety bonds protect the obligee in case the contractor defaults on their contractual or legal obligations.
They ensure adherence to industry laws, licensing rules, and municipal ordinances.
Shows clients that your business is reliable and financially backed, which encourages project owners to work with you.

How to Apply for a Surety Bond?

Contact St. Andrews to determine your boning requirements.
Submit the required documents, including financial statements, project records, and any other supporting documents.
Fill out the form and complete the surety’s evaluation of your credit history and project credibility.
The surety company will review your application and assess your risk profile before issuing the bond. You might be required to sign an indemnity agreement to ensure you’ll reimburse the surety for any claims paid on your behalf.
Once approved, your bond will be issued, and you’ll be able to start using it right away.

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Surety Bonds – FAQs

What are the rules of surety?

A surety bond is a three-party agreement between a principal, an obligee, and the surety. The rules of surety state that the principal must fulfill their contractual or legal obligations, the obligee is protected from financial loss, and the surety guarantees the obligation will be met. Also, if the surety compensates the obligee for financial loss, the principal is obligated to reimburse the surety.

What credit score is needed for a surety?

The minimum credit score required to obtain a surety bond is 650. Applicants with higher scores are more likely to qualify for higher limits and lower premiums.

What is the average cost of a surety bond?

The average cost of a surety bond is between .5% and 10% of the bond amount. This cost is determined based on the applicant’s credit score, experience, and overall risk profile. For example, if you have a high credit score and proven experience, you might pay around $1,000 for a $100,000 bond.

What rights does a surety have?

A surety company has the right to obtain the principal’s financial information to assess their risk profile and assign bond amounts and premiums accordingly. It also has the right to investigate claims, deny invalid ones, and recover losses from the principal if they default.

How long does a surety bond last?

Surety bonds usually last for one year, but the term can vary depending on the type of bond. Some bonds automatically renew annually, while others remain valid only for the specific duration of a project or legal obligation.

Do you have to have collateral for a surety bond?

Yes, most bonding companies may require collateral if the applicant has poor credit, limited financial history, or is considered high-risk.

Do you have to pay the whole amount of a surety bond?

Thankfully, the cost of a surety bond is only around .5% to 10% of the bond’s total amount, and this percentage is called a premium, which is the amount you have to pay to secure a bond.

Does a surety bond affect credit?

No, carrying a surety bond doesn’t affect your credit.

What is an example of a surety bond claim?

A contractor is working on a project that involves several suppliers and subcontractors, but he fails to pay them after receiving funds from the project owner. These parties end up filing a claim against the contractor’s payment bond, and the surety compensates them for the unpaid amounts. The contractor remains responsible for reimbursing the surety.

What is the purpose of a surety bond in real estate?

The purpose of a surety bond in real estate is to ensure compliance with licensing laws, protect clients from financial loss, and guarantee that real estate agents or brokers act honestly and ethically. These bonds also build trust and enhance the business’s credibility.

Is a surety bond a contract of insurance?

No, a surety bond isn’t a contract of insurance. A surety bond guarantees that the principal fulfills their contractual obligations to a third party; meanwhile, an insurance policy protects the insured party against financial losses caused by unexpected events.

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