The purpose of these bonds is to provide reimbursement of a financial loss—typically a loss resulting from the actions or inaction of the principal (the party required to purchase the bond). The terms of the bond spell out the conditions that could result in a claim against the bond. For example, a license and permit bond typically requires the principal to conduct business in a lawful and ethical manner in compliance with the terms of the bond.
Surety bonds that require the principal to sign an indemnity agreement are often referred to as indemnity bonds. An indemnity agreement makes the principal financially responsible for any valid claims against the bond.
Who Needs Them?
Anyone who is required to purchase a surety bond of any kind that includes an indemnity agreement is purchasing this type of bond. Most people, however, won’t refer to it generically as an indemnity bond, but rather as a “contractor’s license bond,” a “car dealer bond,” a “performance bond”—or whatever the bond they need is commonly called.
How Do They Work?
The three parties involved in an indemnity bond of any kind are the obligee that requires it, the principal that purchases it, and the surety that issues it. If the principal fails to perform according to the bond terms, the obligee has the right to file a claim against the bond. For example, if a contractor who purchased a performance bond defaults on the contract without finishing the work, the obligee (the project owner) can file a claim against the bond.
The surety will investigate the claim to make sure it’s valid before paying it. The existence of the indemnity agreement means that even if the surety pays the claimant initially, the principal is legally obligated to reimburse the surety for that amount.
What Do They Cost?
The obligee establishes the required bond amount, and the surety determines what percentage of that bond amount the principal will pay as the premium. The primary factor in that determination is the principal’s credit score. Other factors may be considered, such as the applicant’s financial strength and stability, depending on the specific type of bond.
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