Surety
A promise to assume responsibility if a borrower defaults.
A surety, surety bond, or guaranty is a financial agreement where one party promises to take over a borrower’s debt if that borrower fails to pay. More specifically, a surety bond involves a person or company (the surety or guarantor) agreeing to pay a set amount to one party (the obligee) if another party (the principal) does not meet an obligation, like completing a contract. This bond shields the obligee from losses caused by the principal’s default.
The arrangement is a contract among three parties: the obligee, who is owed the obligation; the principal, who is supposed to fulfill it; and the surety, who assures the obligee that the principal can do the job. In Europe, banks or surety companies can issue these bonds. When issued by banks, they are called “bank guaranties” in English and *cautions* in French; when issued by surety companies, they are simply called surety bonds. In case of default, the surety pays cash up to the bond’s limit, based solely on the obligee’s verified claim, without needing to consult the principal.
Through the bond, the surety agrees to uphold the principal’s contractual promises for the obligee’s benefit if the principal fails to do so. This contract is created to encourage the obligee to work with the principal, showing the principal’s credibility and guaranteeing performance. The principal pays a premium, usually annually, in exchange for the bonding company’s financial backing. When a claim is made, the surety investigates. If valid, the surety pays and then seeks reimbursement from the principal, plus any legal costs. In some cases, the surety gains a right of subrogation, allowing it to “step into the shoes of” the principal and recover damages from another party to offset the payment.
If the principal defaults and the surety is insolvent, the bond becomes worthless. Therefore, the surety is typically an insurance company whose solvency is checked by private audit, government regulation, or both. Nearly every surety bond includes a penal sum—the maximum amount the surety must pay if the principal defaults. This sum lets the surety assess risk and set the premium accordingly. Surety bonds also secure fiduciary duties for people in private or public trust.
Historically, individual surety bonds were the original form. The earliest known record is a Mesopotamian tablet from around 2750 BC. Evidence appears in the Code of Hammurabi and in Babylon, Persia, Assyria, Rome, Carthage, among the ancient Hebrews, and later in England. The Code of Hammurabi, written around 1790 BC, contains the earliest surviving mention of suretyship in a written legal code. Suretyship was not always done via bonds; for example, Frankpledge in medieval England was a system of joint suretyship without bonds. The first corporate surety, the Guarantee Society of London (whose insurance business later merged into Aviva), dates from 1840. In 1865, the Fidelity Insurance Company became the first US corporate surety but soon failed. The US Congress passed the Heard Act in 1894, requiring surety bonds on all federally funded projects. In 1896, the US Supreme Court ruled in *Prairie State Bank v. United States* that a surety’s claim to retained payment percentages had priority over a lender’s claim. In 1908, the Surety Association of America (now the Surety & Fidelity Association of America, or SFAA) was formed to regulate the industry, promote public understanding, and provide a forum for discussion. The SFAA is a licensed rating organization in all states and a statistical agent for reporting fidelity and surety experience. It is a trade association whose members write most US surety and fidelity bonds. The Miller Act replaced the Heard Act in 1935 and remains the current federal law mandating surety bonds on federally funded projects.
A guarantor is typically needed when the principal’s ability to perform is in doubt, or when public or private interest requires protection from default. In most common law jurisdictions, a suretyship contract falls under the Statute of Frauds and is unenforceable unless written and signed by both the surety and the principal.
In the US, the SFAA published preliminary results for the first half of 2022. Direct written premium totaled $8.6 billion, with a direct loss ratio of 14.5%, indicating strong profitability. The industry remains highly fragmented.
- field
- Finance, Law
- known_for
- Providing a guarantee that a principal will fulfill contractual obligations to an obligee
Lore & Background
Suretyship, in its earliest form, did not require a written bond. The original type of suretyship was the individual surety bond, with the oldest known record of such a contract found on a Mesopotamian tablet from around 2750 BC. Later evidence of individual surety bonds appears in the Code of Hammurabi and across ancient civilizations including Babylon, Persia, Assyria, Rome, Carthage, and among the ancient Hebrews, as well as later in England. The Code of Hammurabi, written around 1790 BC, contains the earliest surviving mention of suretyship in a written legal code. A notable alternative system was Frankpledge, a form of joint suretyship common in medieval England that operated without the use of bonds. The first corporate surety, the Guarantee Society of London, dates from 1840. In the United States, the first corporate surety company was the Fidelity Insurance Company, founded in 1865, though it failed soon after. Federal law began mandating surety bonds on all federally funded projects with the Heard Act of 1894, which was later replaced by the Miller Act of 1935. The Surety Association of America, now the Surety & Fidelity Association of America, was formed in 1908 to regulate the industry and promote public understanding. In most common law jurisdictions, a contract of suretyship is subject to the Statute of Frauds and is unenforceable unless recorded in writing and signed by both the surety and the principal.
Reader's Guide
The surety bond is a three-party contract among the obligee (recipient of the obligation), the principal (who performs the obligation), and the surety (who assures the obligee that the principal can perform). The principal pays a premium, usually annually, in exchange for the surety's financial strength. In the event of a valid claim, the surety pays and then seeks reimbursement from the principal. If the surety is insolvent, the assurance is rendered worthless, so sureties are typically insurance companies whose solvency is verified by private audit, governmental regulation, or both. A key term is the penal sum, the maximum amount the surety will pay upon default.
Gallery
Frequently Asked Questions
What is Public Law 25-38 "Surety"?
It is a financial guarantee framework in which one party pledges to cover the obligations of a borrower should that borrower fail to perform. The arrangement shields the receiving party from financial loss caused by the debtor's non-compliance with a contract or duty.
Who are the three parties in a Surety arrangement?
The principal is the one who owes the underlying obligation, the obligee is the party protected by the guarantee, and the surety (or guarantor) is the entity that steps in to pay if the principal defaults.
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