What Are Surety Bonds & How Can They Help You in the UK?

There is a lot of misunderstanding around surety bonds, and we understand why!

If you’ve ever been confused about what surety bonds are, when you’d choose to use surety bonds, or how they differ from insurance, then this is the blog for you.

We sat down with our surety expert, Iain Maitland, working with him to map out everything you need to know about surety bonds. This blog is designed so that you can make an informed decision, whether you’re considering surety for a business venture, or you’re required to take out a surety bond for a project.

What are Surety Bonds Used For?

There are three parties involved in a surety bond: the obligee, the principal and the surety.

The principal is the party responsible for fulfilling an obligation. This is often a contractor, a business owner, or anyone with a specific duty.

The obligee is the party that would be paid if a contract is unfulfilled. This will be the developer, a regulatory body or any other entity that wants to protect their interests and ensure they can recoup funds in the event that a contractor does not deliver.

The surety is often an insurance or bonding company. They provide a guarantee ensuring that, in the event that the principal does not deliver, the obligee is paid an agreed amount.

So, a generic example would be:

The obligee is signing a contract with the principal. To protect their interests, the obligee requires the principal to take out a surety bond, one that stipulates that if the project goes undelivered, the obligee is paid a sum. The principal then approaches a surety, arranges the bond then signs a contract with the obligee.

Surety is provided for a set period, normally in line with the contract period. Premiums are paid at the start of the agreement, but surety providers reserve the right to charge more pro rata premium if projects roll on and on.

What are the Differences Between Surety and Insurance?

Surety bonds are not insurance! The two regularly get conflated as surety is often offered by insurance companies, but they are entirely different products.

Premiums are normally payable by way of a rate on the bond amount, they are usually paid up front, and there are no monthly fees. Premiums are based on the financial standing of the contractor and the period.

Under surety there is a common law right of recourse back to the principal. This is underpinned by a counter indemnity.

What is a Counter Indemnity?

A counter indemnity is a recourse document that is executed by the principal, allowing the surety company the right of recourse back to the contractor if the bond is called – a bond call will normally mean that the contractor has failed and a call will result in a claim.

The counter indemnity is at the core of the agreement as it enables the surety to provide an unsecured line of credit to the company it is bonding.

7 Benefits of Surety

1. Risk Mitigation:

Surety bonds help mitigate financial risk by ensuring that the obligations of one party are fulfilled.

This reduces the risk of default or non-performance by the principal, protecting the obligee and ensuring that a project is finished (or at least that an alternative contractor can be found).

There is always room for negotiation, and some contractors may earn enough trust to not need surety, or to reduce the bond amount, but surety is almost always required when a new contractor is used for the first time.

2. Enhanced Credibility:

Having a surety bond can enhance the credibility and trustworthiness of a business. It signals to clients, partners, and customers that the bonded party is financially stable and committed to fulfilling their obligations.

Surety bonds, such as bid bonds, are commonly used in the tendering process.

Contractors provide bid bonds to demonstrate their commitment to undertaking, and to assure the project owner that they have the financial capacity to complete the job.

3. Legal Compliance:

Some industries and professions in the UK require surety bonds as a regulatory or legal requirement (such as aforementioned regulatory bodies).

Obtaining a bond ensures that businesses comply with relevant laws and regulations.

4. Payment Protection for Subcontractors:

Subcontractors may benefit from bonds, which ensure they receive payment for their services and materials, even if the main contractor defaults on payment.

5. Dispute Resolution:

In the event of a dispute or default, surety bonds can facilitate a smoother resolution process. The surety company may step in to mediate or fulfil the financial obligations as specified in the bond.

6. Market Access:

Having access to a surety bond facility can open up opportunities for businesses to participate in projects or transactions that require bonding. It can broaden the market access for contractors and businesses seeking to engage in specific industries.

7. Free Up Other Lines of Credit

Surety bonds give you the benefit of a financial instrument from a recognised financial institution, allowing you to free up your valuable bank lines.

It’s much better to use your bank facilities for working capital, while using bonds to help you grow your business and win more contracts.