Why Do Businesses Need Surety Bonds?

The short answer

Most businesses obtain surety bonds because a security requirement applies to them. Project owners, government agencies, buyers, courts and regulators require assurance that an obligation will be fulfilled, and where a surety bond is an acceptable form of that security, it can satisfy the requirement without the business locking up cash for the life of the obligation.

Where security requirements come from

• Government procurement. Government procurement may require different forms of security at different stages. Depending on the applicable rules and bidding documents, a surety bond may be an acceptable form for certain security requirements.
• Private contracts. Owners, developers and main contractors often impose their own security requirements on contractors, subcontractors and suppliers.
• Customs and regulatory undertakings. Certain permits, licences and importation arrangements require security as a condition of the undertaking.
• Court proceedings. In specified proceedings, a court may require security for an obligation, and a judicial bond may be the form used.

It is the requirement document itself — the bidding documents, contract, permit or court order — that states what security is required, which forms are acceptable, the amount or percentage, the validity period and the Obligee.

Distinguishing the requirement from the form

Two separate questions are involved. First, what security does the requirement call for? Second, which forms may be used to provide it — cash, a manager's cheque, a bank instrument, or a surety bond? A surety bond is one possible form where the applicable rules and documents allow it, and the percentages that apply can differ depending on the form offered.

What a bond gives the party requiring it

Where a bond is used, the Obligee gets a defined undertaking from a regulated company, limited to the bond amount and to the bond's terms, if the bonded obligation is not fulfilled. That is one reason bonds are widely accepted as a form of security.

Why a bond rather than cash

A cash deposit ties up funds for the whole period of the obligation — funds that would otherwise pay for mobilisation, materials, payroll and other running costs. Where a surety bond is acceptable, it replaces that deposit with an undertaking from a Surety in exchange for a premium, which is why preserving working capital is the most common commercial reason businesses use bonds.

Bonds a business may encounter

• Bid bond or bid security — in connection with submitting an offer.
• Performance bond or performance security — in connection with performance of an awarded contract.
• Advance payment bond — where a mobilisation or advance payment is released.
• Payment bond — addressing payment to workers, suppliers or subcontractors.
• Warranty or maintenance bond — covering a stated warranty or defects liability period.
• Customs and judicial bonds — where an agency or court requires security for a specific undertaking.

Which of these applies to you, and in what amount, depends on the requirement document.

A second, practical benefit

Because a Surety reviews an applicant before issuing, being bondable is often read as a sign that a business keeps its records, financials and commitments in order. That is a by-product of the process rather than the purpose of the bond, but it matters commercially — a business that cannot organize the documents a Surety asks for will struggle with the requirements that follow award.

Key takeaway

Security requirements usually come with the work rather than being optional, and where a surety bond is an acceptable form, it lets a business meet the requirement without immobilising cash for the length of the obligation.