Entering into a contract or agreement carries an element of risk. One way of managing the risk that a contract will not be performed is to make it a surety bond. In this article, we’ll explain what a surety bond is and how it can be used to reduce contractual risks.Â
What’s a Surety Bond?
Put simply, a surety bond is a contract between three or more parties. These parties are:
- The party who receives the obligation;
- The party who performs the obligation; and
- A third party who is known as the ‘surety’.
The key difference between a surety bond and other contracts is the presence of the surety. Under this agreement, the surety agrees to inherit the contractual obligation of the second party if they fail to perform it.Â
The presence of a surety reduces the risk in the contract for the first party. This makes this kind of contract attractive for particular deals.
Examples
Example A
The NSW Government wishes to build a new hospital. Consequently, they hire construction company A to do the work for them. In order to facilitate the new hospital’s construction, the parties enter into a contract. In the contract, there is a special condition that states that construction company B agrees to perform the contract should company A be unable to. This contract is a surety bond.
Example B
Luke would like to buy his first house and requires a loan. Generally, if the bank is unsure whether to approve Luke for a loan or not they may encourage him to get someone to guarantor his loan if he can. If for instance, Luke was able to get a family member or someone else to act as guarantor for his loan then the loan would be a form of surety bond.
Summary
In summary, a surety bond is a form of contract or agreement between three or more parties. The key feature of this agreement is the existence of the ‘surety’. The ‘surety’ is the third party who agrees to perform one party’s obligation under the contract if they are unable to. Above all, should you need to create a contract it is best to seek professional legal advice.
