Bond of Indemnity vs Indemnity Agreement

The concept of ‘indemnity’ may be confusing to those unfamiliar with surety or contracts. As it pertains to surety for example, a bond of indemnity and an indemnity agreement may sound similar, but are uniquely different.

What is a Bond of Indemnity?

How is this different from an Indemnity Agreement?

When is the Principal required to repay the Surety?

A bond of indemnity, also called an indemnity bond, is a type of surety bond. Surety bonds are insurance products that secure a financial risk associated with a particular transaction, much like cosigning a loan. The bond provides a guarantee that the bonded company or person will perform its obligations in good faith. Failure to do so may trigger a requirement that the surety company who provided the bond step up in its place. Should circumstances arise where the principal cannot perform, the obligee may incur serious loss. In these situations, the bond offers the oblige protection and would go into effect to remedy, preventing those losses. A few examples are:
Considered an extension of credit, a bond or surety is a promise by a guarantor (the surety company) to pay one party (the obligee) a certain amount if a second party (the principal) fails to meet some obligation, such as fulfilling the terms of a contract. The surety bond protects the obligee against losses resulting from the principal’s failure to meet the obligation. In other words, the bond provides a guarantee that the bonded company or person will perform its obligations in good faith. Failure to do so may trigger a requirement that the surety company, who provided the bond, steps up in its place. In that case the surety company is obligated to find a principal replacement to complete the contract or compensate the obligee for the financial loss incurred.
 
  • Project timeline not followed or deadlines missed

  • Substandard work or not completed to spec

  • Vendors, suppliers or subcontractors involved in project were not paid

  • Materials or resources fail to arrive or are low quality

  • Regulations or laws are broken during the performance of the project

  • Contractor negligence or bankruptcy

A bond of indemnity ensures the obligee that the contractual obligations of a project will be completed, even if the principal engaged in actions that would cause a default or failure to complete the project. There are often specific conditions outlined in the bond that indicate when the obligee can make a claim against it. For any claim, the surety company will conduct a thorough investigation into the principal’s actions in adhering to contractural obligations before determining paying out the claim or denying it.
When the surety company finds that the obligee has a legitimate claim, they will provide remedy or payments up to the total amount of the bond. If the principal’s actions led to more financial damages or loss above that amount, the obligee will have to directly seek compensation from the principal through legal actions.
Once the surety company has paid claims, they will seek repayment from the principal. The principal is legally obligated to repay the full amount. In this way, a bond is not the same as insurance. Instead, it serves as a type of credit extension. The surety company pays the obligee from their own funds, then seeks repayment.

Different types of Indemnity Bonds

There are numerous types of indemnity bonds available and they are as varied and diverse as the industries they cover. These bonds can cover projects in their entirety as well as detail-specific aspects. Here are a few more common bonds:

Different types of Indemnity Bonds

  1. Bid: When a contractor is awarded a bid, they are entering into an agreement to cover all of the necessary costs that go along with completing the project as presented in their formal submission. The agreement guarantees that the principle will abide by the bid price and terms as awarded as well as obtain any other bonds that may go along with fulfilling the obligations of the bid.
     

  2. Performance: This guarantees that the terms and conditions of the agreement will be met with respect to all aspects in the scope of work being done. All work must be completed in compliance with safety, quality, and timeline expectations and guidelines, in addition to any special stipulations agreed to by the obligee and principle as laid out in the contract.
     

  3. Payment: This bond ensures that all other persons involved in the project will receive prompt and full payments for their services. This includes subcontractors, vendors, material manufacturers or suppliers, and laborers.
     

  4. Licenses and Permits: This guarantees special certifications or training required by professionals to complete their respective jobs function or service, as well as governmental regulations or laws that require specific written permits or waivers relating to the performance or completion of the job.
     

  5. Miscellaneous: These types of bonds are used to cover highly specific items not generally found in standard agreements or contracts. They can be virtually anything stipulated by the obligee covering materials, services, or expectations. They can sometimes be legally required for special or unique circumstances.

There are three parties involved in a bond of indemnity are:

 

The principal as the service provider. It is their duty to complete the agreed-upon project under the terms outlined in the contract using legally approved actions, methods, and conduct. The principal secures an indemnity bond as a way of ensuring their client that project will be completed.

 

The obligee hires the principal or works with them as defined in the contract. The obligee pays the principal the agreed amount throughout and upon completion of the contract. If the obligee believes the principal has violated the contract through their conduct or by failing to act according to their agreement, they may file a claim against the bond with the surety.

 

The surety company provides the bond of indemnity to the principal which benefits the obligee. They collect a fee, or premium, for issuing this bond due to taking on the risk associated with it. The surety investigates any claim the obligee makes against the bond and will pay up to the amount of the bond should the claim be approved.

How is this different from an Indemnity Agreement?

The Parties Involved

There are a number of different industries that use indemnity bonds. In some instances, the principal is legally required to have an indemnity bond before beginning a project. In other cases, the obligee may require a bond in their contract. Some companies take out indemnity bonds for each contract as a way of providing a guarantee to their clients. Below are a few of the industries that make use of indemnity bonds:

 

  • Contractors

  • Construction companies

  • Auto dealers

  • Mortgage brokers

  • Local, state, and federal government agencies often require contractors to be bonded in order to be awarded government contracts

What companies use Indemnity Bonds?

When an obligee believes that the principal has acted in a way that violates their agreement, they may make a claim against the indemnity bond through the surety. In some cases, another party may even make a claim, provided that the obligee has empowered them to do so. There can be many different reasons why the obligee is making a claim. The legal obligations and duties the principal is required to perform do vary between contracts.

Typically, the obligee submits a written notice of their intent to file a claim to both the principal and the surety. The surety company generally attempts to negotiate between the two parties first. They also begin to investigate the claim to determine if it is valid. If no agreement can be reached and the claim is valid, the surety company will pay the obligee compensation up to the total amount of the bond. The principal will then have to repay the surety company.

An indemnity agreement is a contract between the principal and surety that is made at the time the principal procures their bond of indemnity.. Simplified, it states that should the surety have to pay out on a claim from the bond, the principal will pay them back. It ensures the surety to a legal path of reimbursement should a claim made against the principal be valid, thus at the Surety’s expense.

 

If no claims are ever made against the bond, the indemnity agreement is never triggered.

 

An indemnity agreement is designed to protect the surety company in the event of a valid claim. Otherwise, the principal may not be legally required to compensate the surety company after the surety has paid out on a valid claim. Hence, the likeness to a credit extension.

Who Signs the Indemnity Agreement?

When is the Principal required to repay the Surety?

When is the Principal required to repay the Surety?

Unlike the bond of indemnity, the obligee has no part in the indemnity agreement. Only the principal and the surety company are parties to the agreement. However, it is important to note that the owners of the principal may have to sign the agreement or provide a personal guarantee. This is because the surety company may seek repayment from the personal finances of the owners if the business itself is unable to cover the costs.

 

In the past, business owners would often get around the indemnity agreement by putting all or most of their assets in their spouse’s name. By making it a requirement that spouses also sign the indemnity agreement, surety companies are able to close this loophole.

In almost every case, the principal is required to repay the surety when the surety validates a claim made by the obligee. Should the principal refuse, the surety can take legal actions to collect their compensation.

The key differences between the bond of indemnity and the indemnity agreement is who pays whom:

 

  • With a bond of indemnity, the surety company pays the obligee compensation when the principal fails to uphold the contract.

  • The indemnity agreement then requires the principal to repay the surety company.

 

The bond of indemnity is designed to ensure that the contract the obligee hired the principal to execute is completed. It ensures that the obligee does not endure loss and is not forced to hire another company to complete the project. The indemnity agreement, on the other hand, makes certain that the surety company does not lose money when they pay out on a claim.

 

A surety company will always include an indemnity agreement in any bond written.

 

We invite you to contact our specialists at Raffuel Surety Group for an in-depth discussion about your surety requirements at info@raffuelsurety.com or call to (609) 924-2426.

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Email: info@raffuelsurety.com
Tel:  +1(609) 924-2426

 

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