Meaning of Indemnity Bond
The word indemnity itself refers to the process of protecting a party against financial loss which might occur as a result of actions by some other party. In a legal context, indemnity can be enforced in a contract between parties, wherein one party agrees to perform some action, and by defaulting on that action, may cause financial harm to occur to the second party in the contract.
An indemnity bond is type of surety bond which, as in all surety bonds, involves three main parties, the principal, the obligee, and a surety company. The surety company is generally an insurance firm which issues the bond, the principal is the individual purchasing the bond, and the obligee is the person being protected by the bond. Often used in mortgages, these bonds might be insisted upon by the lender, who in this case would also be the obligee.
The involved principal would be the borrower in the mortgage transaction, and would be obliged to purchase the bond for the protection of the lender. If the involved principal then failed to live up to the contractual obligations set forth in the bond, the obligee would have the right to make a claim against the bond to recover the full amount owed. While the surety company would pay the initial amount of any claim made, the surety would then be free to pursue the principal to recover the amount of its loss.
What is Indemnity Bond
How They Work
When a surety company is obliged to pay the amount of a claim made against an indemnity bond made by a specific obligee, it would of course suffer an immediate loss. However, under the terms of the indemnity contract, it would have the right to recover any losses incurred by legally pursuing the principal to make good on those losses. The personal and corporate assets of the principal would become fair game in such cases, under the guidelines of the indemnity contract, and this could even be legally pursued in a court case.
Any individual or company which failed to pay the amount of a claim made against these bonds would suffer a serious loss of reputation, as well as any legal action which might be brought against it. It could also result in bankruptcy for the defaulting company, if it is for some reason unable to pay the amount of a claim made against the bond agreed to.
When they are needed
There are a great many situations where these bonds might be needed, as you might infer from the definition described above. Literally almost any case where an obligee might suffer some kind of financial loss as a result of a principal failing to live up to the obligations specified in an indemnity contract would be a situation where such a bond would be called for.
The construction industry is one where indemnity bonds are often used as a guarantee of contractor performance. For instance, when a project manager would stand to lose considerable income if the electrical work were to not be completed on time by a contractor, the project owner might require a bond to be purchased by the electrical contractor, as a guarantee against suffering losses.
These bonds might also be purchased by an instructor at an educational institution, because that institution insists on maintaining its reputation and avoiding any losses which might occur as a result of any change in the instructor’s status. As an example, it could happen that the instructor experiences a loss of reputation for some reason, and the educational facility strongly desires to avoid a similar loss of reputation, so it will invoke the bond claim as a result.
Another example of when they would be needed is in a situation where someone loses a share certificate for stock. To recover the full value of that certificate, it would be necessary to approach the certificate-issuing authority and prove that you are the legitimate owner of that certificate. The authority would probably then require that an indemnity bond be purchased, so that it does not lose the value of the share, if the original certificate surfaced and is claimed by another party.
There are also government indemnity ‘schemes’, which offer an alternative to the high cost of insurance for art galleries as an example, to display certain artifacts or paintings to the public, as a guarantee against any damage which might occur to the artwork in the process.
When applying for an indemnity surety bond, it can be extremely important how the contract language is worded, because the terms of the indemnity contract will be used to justify the reasoning for an obligee to make a claim against the contract. This means the obligee will have a vested interest in making sure that the language of the indemnity contract is such that it adequately covers their rights in pursuing a claim, in the event that the principal does default on the performance of some task, or in some way cause the obligee to suffer a financial loss.
The first step in obtaining a bond is to locate a surety company which is authorized to sell them in your state, and this can be done very easily online. Then, an application form would have to be filled out and submitted to the insurance firm (the surety company), after which it would conduct a background check on the applicant, for credit-worthiness and for any criminal record. Surety by NFP for all your bonding needs. We can write all bond types in all states! What is Indemnity Bond …call us to learn more.
Indemnity Bond Cost
Based on the credit history of an applicant, a percentage amount would then be quoted as a premium to be paid for the bond. For instance, an individual or company with good credit history might only be assessed 1% of the bond amount as a premium to be paid, whereas an individual with spotty credit might have to pay 3% or 4% of the bond amount. This is because of the increased risk to the surety company, that premiums would not be paid monthly as they should be.
Assuming all three parties are in agreement over the terms of the bond and its cost, the bond would then be issued to a principal, and coverage would commence at that point. Reach out to Surety by NFP to learn more about the meaning of indemnity bond, and get the ball rolling today!