A surety bond is a specific type of bond which involves three different parties. The first party is the principal — this is the person or organization who is being secured against default. The second party is the obligee — this is the person or organization who is owed money or labor. The third party is the surety — this is the person or organization who is promising to pay a certain amount should the principal default.
Surety bonds may be used in an incredibly wide range of circumstances. They are basically used any time an individual or group is expected to do something, and some further assurance of their compliance is needed.
The principal enters into a contract with a surety, usually an insurance organization or underwriter, basically promising that they will reimburse the surety if they default on their obligation to the obligee. If they do default, the surety gives the agreed upon amount of money to the obligee. The principal is then legally required to reimburse the surety, including any losses and expenses the surety has acquired handling their case. Since the surety in this case is a lender, it is granted the same rights in getting its loss back from the principal as any other lender would have — this is in contrast to typical insurance, in which the insurance company is much more seriously limited in its legal recourse.
Types of these bonds include contract bond, court bonds, bail bonds, and license bonds, though there are other types as well. Contract bonds are needed when the principal is given a contract to perform some sort of building or maintenance job. Since the contract may stipulate a range of specifications, a maximum cost for the project, and a time until completion, the obligee may require a surety that the contractor will fulfill the contract appropriately.
Court bonds are often required by a court before a principal tries to file some types of claims or injunctions, or tries to appeal a case. In the event that the principal fails at what they set out for -- acquiring a restraining order, for example -- the court may require them to pay court costs and perhaps a fine if the case was wrongfully pursued. Surety in this case obligates the principal to pay these costs if they are incurred, before the principal uses the court's time.
Bail bonds are one of the most well-known types of surety bonds, though also one that many large insurance companies and banks will not issue. A bail bond basically promises the court that the principal will show up at an appointed court date; if the principal does not show up, the surety pays the court a fine and collects from the principal. Since bail bonds have such a high default rate, their issuance is often taken up only by a handful of specialists, who may then charge rather exorbitant penalty and interest rates.
License surety bonds are usually necessary when starting a new business or acquiring a new type of license for an existing business. The principal in this case is the business owner, who is getting surety that they will comply with all of the requirements set out by the license. The obligee is the state or local government who is issuing the specific license, and they are paid if the principal does not conduct themselves with accordance with license requirements.