What is a Surety Bond?

Surety bonds are financial agreements guaranteeing that a party will fulfill their contractual obligations, providing assurance and risk mitigation for businesses and project stakeholders.
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3 mins read
25-July-2025

Let us say you are a contractor bidding on a government project, or a business applying for a major service license. One thing you will likely be asked for is a surety bond. Why? Because it’s a simple way to prove you can be trusted to meet your obligations and that if anything goes wrong, the other party will not be left in the lurch financially. Surety bonds are common in industries where large sums of money or public interests are involved, like construction, legal services, or government contracts. But they’re not just for big companies. SMEs, service providers, and even individuals can benefit from the financial protection and credibility that a surety bond provides.

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What is a surety bond?

A surety bond is a written, legally enforceable agreement between three parties:

  1. The principal – the person or business that needs to perform a duty or complete a project.
  2. The obligee – the person or entity that requires assurance the task will be done.
  3. The surety – the financial institution or company that guarantees the principal’s obligation.

If the principal fails to meet their obligation, the surety steps in and compensates the obligee. The principal, in turn, must repay the surety. In India, surety bond insurance is gaining popularity as a secure way to ensure contract compliance and risk mitigation especially in construction, infrastructure, and public procurement. It’s a professional promise that builds trust.

Interesting fact: Surety bonds are not the same as insurance. They do not protect the principal; they protect the obligee.

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How does a surety bond work?

Let us say a builder is hired to construct a government facility. The government wants a surety bond to make sure the work gets completed. The builder gets a surety bond from a trusted financial company. If the builder walks away halfway, the government (obligee) can raise a claim, and the surety pays them for losses.

The builder (principal) is then responsible for reimbursing the surety.

Here is what happens behind the scenes:

  • The surety provider assesses the principal’s creditworthiness, financial records, and project experience.
  • The bond’s value (limit) is determined based on project risk and scope.
  • If things go wrong, the surety pays the obligee and then recovers the cost from the principal.

This cycle ensures accountability and builds confidence between businesses.

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Types of surety bonds

There are different types of surety bonds depending on the purpose and the industry. Here are the major categories:

1. Contract bonds

These are mostly used in construction, infrastructure, and large projects. They include:

  • Performance Bonds: Guarantee that the work will be completed as per agreed terms.
  • Payment Bonds: Ensure that subcontractors, suppliers, and workers are paid on time.
  • Bid Bonds: Required at the tender stage to show serious intent and financial backing.

2. Commercial bonds

These are used by businesses and are often required by government authorities.

  • License and Permit Bonds: For businesses that need a license to operate legally.
  • Compliance Bonds: Ensure that companies follow applicable laws, such as tax or environmental regulations.

3. Court bonds

Used during legal proceedings.

  • Appeal Bonds: Filed when a party wants to appeal a court decision.
  • Probate Bonds: Required when someone is appointed to manage another person’s estate.

4. Fidelity bonds

These protect companies against internal risks such as:

  • Employee theft
  • Fraud
  • Forgery

Each of these bonds helps protect the obligee and builds a secure environment for business.

Benefits of surety bonds

Surety bonds offer more than just legal compliance. They come with a wide range of benefits for all parties involved:

  • Ensures contract fulfilment: No more worrying about unfinished jobs or broken promises.
  • Financial protection: Obligees are compensated if the principal fails to meet obligations.
  • Regulatory requirement: Many industries make it mandatory to have surety bonds before granting licences or work orders.
  • Boosts reputation: Businesses with surety bonds are viewed as financially stable and dependable.
  • Increases project eligibility: Having a bond can help a business win more contracts especially in government or infrastructure sectors.

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NBFC and surety bonds

Traditionally, surety bonds were issued by banks and insurance companies. But now, the Reserve Bank of India has allowed Non-Banking Financial Companies (NBFCs) to enter the market. This is a big win for businesses, especially SMEs.

NBFCs like Bajaj Finserv now offer surety bonds with:

  • Flexible underwriting criteria

  • Faster turnaround times

  • Tailored bond solutions for your project or industry

By working with an NBFC, you can skip the red tape and still get the same level of assurance that a traditional surety bond offers.

This opens up access for a wider range of businesses—including startups and mid-sized companies—that may not meet conventional banking norms but have credible business models.

Surety bond vs. insurance

People often confuse surety bonds with insurance, but they serve very different purposes.

Here is how they compare:

Feature

Surety Bond

Insurance

Who is protected?

Obligee (third party)

Insured person or business

Who pays claims?

Surety pays, but principal must repay

Insurer pays and absorbs the loss

What does it cover?

Contractual obligations, non-performance

Unpredictable risks and events

Main purpose

Guarantee performance

Mitigate risk or loss

Premium calculation

Based on contract size and financial profile

Based on coverage amount and risk factors

In short: Insurance transfers risk, but a surety bond enforces responsibility.

Who needs a surety bond?

Surety bonds are essential in several scenarios, such as:

  • Contractors and construction firms bidding for government or large private projects
  • Suppliers and vendors working with public sector units
  • Legal professionals handling estates or filing appeals
  • Businesses applying for licenses in regulated sectors like telecom, finance, or transport
  • SMEs entering formal contracts with large clients or government agencies

If your work involves contracts, public accountability, or government compliance, a surety bond isn’t just helpful it’s often mandatory.

What is a surety limit?

A surety limit is the maximum value that the surety is willing to cover under the bond. Think of it as the upper cap of protection for the obligee.

The limit is decided after evaluating:

  • The size and nature of the project
  • The risk involved
  • The financial standing of the principal
  • The type of surety bond being issued

Higher the risk, stricter the evaluation, and possibly higher the premium.

How to apply for a surety bond?

Applying for a surety bond is more straightforward than you might think. Here’s how the process usually works: 

  1. Find a surety provider – Choose a reputed NBFC like Bajaj Finserv that offers bond services for your sector.
  2. Share project and financial details – These could include income statements, balance sheets, work history, and project scope.
  3. Underwriting assessment – The surety provider reviews your ability to complete the work or meet the obligation.
  4. Bond issuance and premium payment – If approved, the bond is issued. You pay a premium, usually a percentage of the bond amount.

The key is transparency. The more information you share, the smoother the process.

Conclusion

Surety bonds are more than just documents they are financial commitments that build trust, safeguard contracts, and ensure everyone plays fair. From construction to compliance, these bonds help keep the wheels turning smoothly in industries that rely on accountability. And if you are looking to unlock liquidity, remember you do not have to sell your investments.

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Frequently asked questions

What happens if the principal defaults on the Surety Bond?
If the principal defaults, the surety steps in to fulfil the obligation, either by paying the obligee or completing the project. The principal is then required to reimburse the surety for costs incurred.

How does the underwriting process for Surety Bonds work?
The underwriting process involves assessing the principal’s creditworthiness, financial stability, and project feasibility. This evaluation helps the surety determine the risk involved and the premium for the bond.

What is a Performance Bond, and how does it differ from other Surety Bonds?
A performance bond specifically guarantees that a project or contract will be completed as agreed. Unlike other surety bonds, it directly ensures the fulfilment of performance obligations.

Can Surety Bonds be renewed or extended?
Yes, surety bonds can typically be renewed or extended, depending on the project requirements and agreement with the surety provider, often involving an additional premium.

Is collateral required to obtain a Surety Bond?
While not always required, some surety providers may request collateral, especially if the principal poses a higher financial risk, to secure the bond and protect the obligee.

Who can issue surety bonds in India?

In India, surety bonds can be issued by insurance companies approved by the Insurance Regulatory and Development Authority of India (IRDAI). These bonds provide financial security for contractual obligations.

What is the difference between a surety bond and a bank guarantee?

A surety bond involves three parties (principal, obligee, and surety) and ensures contractual compliance, while a bank guarantee is a financial commitment where the bank directly compensates if the applicant defaults.

Who can issue surety bonds in India?

Surety bonds in India can be issued by insurers licensed by the Insurance Regulatory and Development Authority of India (IRDAI). Only registered general insurance companies, like Bajaj Allianz General Insurance, are authorised to issue them.

How do I apply for a surety bond?

You can apply online by visiting the lender’s online platform and submitting project details, bond type, and required documents. The insurer will assess your eligibility and provide bond terms based on your financial and contractual profile.

How long does it take to get a surety bond issued?

Issuance time depends on the bond type and your financial profile, but it typically takes 3–7 working days after submitting all required documents and completing due diligence checks by the insurer.

Do surety bonds affect my credit score?

Surety bonds do not directly impact your credit score. However, insurers may review your credit and financial history during evaluation, and any default on the bond could indirectly affect your creditworthiness.

Are surety bonds refundable?

Surety bond premiums are generally non-refundable, even if the bond is never used or the contract is terminated early. This is because the premium covers the insurer’s underwriting risk and issuance service.

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