Guide to Surety Bond Indemnity Agreements
General Indemnity Agreements Explained
Surety bonds are three party contracts between the principal, the surety and the obligee. By providing the principal with a bond, the surety is guaranteeing to the obligee that money is available to cover the cost of damages as a result of the principal’s failure to adhere to the terms of the bond. However, one major difference between surety bonds and insurance is that surety underwriters issue bonds with the assumption that the surety will not lose any money if a claim is made against the bond.
So, if the surety guarantees to the obligee that money is available to cover damages where the principal is at fault, how can the surety assume that they will not lose any money? Through an important contract known as the indemnity agreement.
Common Questions About Indemnity Agreements
Q: What is an indemnity agreement?
A: A surety bond indemnity agreement is a contract between the principal and the surety company, that transfers risk from the surety to the principal. While the bond itself is created by the obligee, an indemnity is a separate agreement that the surety requires the principal to sign prior to issuing the bond that guarantees the principal is responsible for repaying any money paid by the surety in the process of settling a claim.
Because the bond guarantees to the obligee that money is available, the bond acts similarly to a line of credit in that the principal does not have to set aside their own money in case of a claim. The surety will do it for them and cover the cost of a claim upfront, but the principal must then pay them back, and it is the indemnity agreement that ensures this will be done.
Q: Who signs the indemnity agreement?
A: Every individual whose ownership of a business is 10% or greater will be required to sign individually and on behalf of the company before a bond is issued. The reason that they must sign as individuals in addition to the company is so that, if there is a claim and the company does not have the means to repay the surety, the surety may then look to the owners in order to collect.
Aside from the owners of the company, the surety will also require their spouses to sign the indemnity. Oftentimes, the person signing the indemnity is unsure of why their spouse has to sign when he or she has no involvement with the business. The reason that spouses need to sign indemnity agreements is because the married couples often share assets, and by having both signatures, the surety can be certain that the owners of the business will not transfer their assets into their spouse’s names in order to avoid repaying the surety for a claim.
Before underwriters provide a quote, they assess the likelihood of a claim and the principal’s ability to repay the cost of that claim. There is a certain amount of trust involved when issuing a bond, so if the principal is unwilling to have their spouse sign the indemnity, then it will raise red flags on the principal’s trustworthiness, ultimately leading to a denial for the bond. In short, if the principal is married, their spouse must sign the indemnity agreement.
Q: What happens if the principal doesn’t repay the surety?
A: Again, surety companies issue bonds with the assumption that there is zero risk of financial loss on their part. It is important to remember that a bond is similar to a line of credit because it prevents the principal from tying up their own money, but if a claim is filed and the principal is unwilling to repay the surety, the indemnity agreement gives the surety the right to take legal action and collect repayment. This is because, by signing an indemnity, the principal transfers liability for damages from the surety to themselves.
Q: Do all bonds require an indemnity agreement?
A: Not necessarily. The greater the likelihood of claim activity or risk within an industry, the higher likelihood the bond amount will be greater and require a closer look at the application by an underwriter.
For some bonds, the surety determines that the bond amount is minimal and/or the risk of claims is low enough that the bond may be issued without a credit check. When a bond may be issued instantly without the application being subject to underwriting, no indemnity agreement is required.
Conversely, every application that is subject to underwriting will also need to be accompanied by a signed indemnity before the bond may be issued. The reason that an indemnity agreement is required with all underwritten bonds is because the surety sees them as being more risky, often times due to a high bond amount or language on the bond form that increases the likelihood of a claim.