An indemnity bond, also known as a surety bond, is an insurance policy that protects one party from damage, loss or failure caused by another. Protection can take the form of compensation or legal exemption from liability. Commerce, industry and public administration depend on indemnity bonds to assure continuity in the supply of goods and services, and to protect the public from failing businesses. Different circumstances call for different types of indemnity bond.
How it works
An indemnity bond is a three-way legal contract between an obligor, obligee and a bonding or surety company. The obligor (also known as promisor or principal) promises to provide goods or services for the obligee, and buys a bond to guarantee supplying these to the right standard. The obligee (or promisee) promises to pay for the goods or services and requires the obligor to buy the bond as part of the contract. The surety is the company that sells the indemnity bond to the obligor. The bond guarantees that the surety company will pay compensation to the obligee if the obligor fails to fulfil the contract. If it has to pay out, the surety company will try to get its money back from the obligor.
Professional indemnity insurance
PII pays out if a contractor is negligent or makes a mistake that causes the client financial loss. Contractors and freelancers may need it if they handle clients’ data, provide advice or could be challenged on the quality of their work. Local councils take out indemnity bonds to cover the professional work done by their employees on behalf of the council.
Contractors buy performance bonds from banks or guarantee companies to guarantee to the client or employer that the client will be compensated if the contractor fails to deliver.
Employers, for example, local authorities commissioning new house or road construction, may take out an advance payment bond as part of the contract. This guarantees they will pay the contractor upfront for goods or services actually provided, even if the contractor later fails to complete the rest of the work.
Buying a home
A lender such as a bank or mortgage company (the obligee) may require a bond from the homebuyers (the obligors) in case they fail to repay their loan in full, or have to sell their house while it is in negative equity (worth less than the loan amount). The indemnity bond, which may be called a mortgage indemnity guarantee, pays the difference to ensure the lender gets its money back.
Buying companies or shares
An indemnity bond can make good any losses suffered when buying a company as a result of its previous owners’ past actions; for example on discovering previously undisclosed or forgotten debts or tax liabilities. An indemnity bond can also protect a shareholder from claims arising from the cost of replacing lost certificates.
Government indemnity schemes
The UK government takes out indemnity cover on public events and cultural schemes, for example, to cover authorities running elections or museums setting up exhibitions. It also issues rules and guidance on indemnity insurance for employers. The government’s UK Export Finance Bond scheme helps keep foreign trade going by offering mutual protection to exporters, banks and overseas buyers.