https://www.cavignac.com/2022/01/surety-101-for-contractors-part-i-types-of-bonds-their-purpose/

The primary driver for requiring bonds is the Miller Act. This Act was enacted in 1935 in an effort to protect the interest of taxpayers, the federal government and subcontractors in constructing federal projects. It requires prime contractors provide bid, performance and payment bonds for any contract exceeding $150,000 to construct, alter or repair any public building or public work. Most states also have what are commonly referred to as a Little Miller Acts (LMAs), applying the same concept as the federal Miller Act for construction projects at the state and local level. These LMAs can have a lower threshold for requiring the bonds (i.e California does not require payment bonds for projects under $25,000). Other entities that may require bonds for construction projects include universities, colleges, and school districts among others.

There are three parties to a bond – the Principal (contractor), the Obligee (project owner) and the Surety (typically an insurance company). Each party has different responsibilities as it relates to performance, notices and remedies in the event of a claim. In the most basic terms, the Principal is liable to the Obligee to complete the scope of work in the amount of time allotted in the contract, and to pay their subcontractors and suppliers under the contractual terms. The Obligee is required to fulfill its requirements under the contract. In the event either party does not fulfill its obligations, the likelihood of a termination or default from either party increases substantially.

The third party to the bond – the Surety – is obligated to “step into the shoes” of the Principal (contractor) in the event the Obligee calls upon either a Performance or Payment bond. Depending on the contract terms and bond form used, the Surety has various options when this occurs, which include (in the most basic sense):

Financing the Principal through the completion of work
Hiring an alternative contractor to complete the remaining work
Making payment to the Obligee for the balance of remaining work and associated costs
These options are evaluated by the Surety as they complete an in-depth review of the issue that caused the Obligee to make a claim on the bond. It is the Surety’s responsibility to make this assessment and work to resolve the issue with the Obligee as expeditiously as possible. In the event of a claim, it is to the Principal’s benefit to have open communication and transparency with the Surety to ensure the most favorable resolution to the claim.