Surety bonds are like insurance: better to have it and not need it, than to need it and not have it. Like insurance, surety bonds put the resources of huge underwriters behind corporations or individuals, allowing them to conduct business while offering peace of mind to their customers.
There are three basic parties to a surety bond. The Principal is the one responsible for obtaining the bond, and whose work performance is the subject of the bond. The Obligee is the beneficiary of the bond, and usually is paying the Principal for the work covered by the bond. The Surety is the underwriting company who researches and issues the bond, and who pays in the event a valid claim is made against the bond.
Each party to a surety bond receives some form of benefit. The Obligee receives compensation for breach of contractor or unsatisfactory work without the time consuming process of going to court. The Principal is able to acquire and perform jobs by meeting the bond requirements of work contracts. And, of course, the Surety calculates their rates to generate a profit by underwriting bonds.
There are two main types of surety bonds. Contract bonds relate to work done under a specific agreement, often related to building construction, but also includes bid bonds, bail bonds, and several other types of bonds. Here, the builder is the Obligee and a company contracted to undertake an aspect of the project is the Principal. The second type, a commercial surety, is similar, except the bond is a requirement for obtaining a specific kind of license or permit. For example, a notary must be bonded against claims of negligence or fraud for the benefit of their clients. In a commercial surety bond, the licensed or permitted entity is the Principal and the Obligee is any unspecified person who engages the Principal in transactions related to the bonded purpose.
The existence of surety bonds transfers risk, thereby facilitating business. If a builder had to sue a contractor to enforce an agreement, they would assume massive losses for all the time work was not performed. If permitted individuals or businesses were not bonded, customers might not patronize them for fear of loss, and the businesses themselves might not perform certain activities to avoid the risk.
Though it is the Surety who pays the Obligee in the event of a claim against the surety bond, this does not indemnify the Principal. In fact, under the terms of the bond, the Surety will likely be able to collect its costs from the Principal, even if it means taking them to court or bankrupting them. The purpose of the bond is simply to guarantee swift and complete payment to the Obligee.