This is Part 1 of our two-part post on indemnity agreements. Continue with Part 2 here.
Indemnity agreements are a standard document in the surety and insurance industry, but for those outside the industry, they can be relatively unknown. If you are not a lawyer, they can be near impossible to understand. If you are not someone working in the surety or insurance industry, it can be difficult to navigate who needs to sign it. This blog post will hopefully answer the questions regarding what an indemnity agreement is, who needs to sign it, and why they are required.
Before these questions can be answered, it would be helpful to define some terms to ensure maximum clarity. To start, Surety and surety company can be used interchangeably. These terms refer to the company that writes and issues bonds, as well as takes financial responsibility for paying out a loss on the bond. They have a stake in the bond and they must pay the surety company back if a claim is filed on the bond. Next, indemnify means to compensate someone for loss or financial harm. Next, indemnity means security or protection against a loss or other financial burdens. It can also mean the compensation for lost of the original financial condition of the surety company before the loss was incurred. Lastly, an indemnitor is a person or entity who gives indemnity. They sign the indemnity agreement, and if there is a loss on the bond, they become responsible for paying the surety back.
A surety bond is an agreement between three parties that guarantees something. The three parties involved in the issuing of a surety bond are the obligee, the principal and a Surety. The obligee is the person or entity that requires the bond. Obligees do not play a critical role in indemnity agreements. The bond principal is the person or entity who buys the bond. A Surety is the person or entity who issues the bond. Indemnity agreements happen between the bond principal and Surety.
An indemnity agreement is essentially a risk transfer mechanism. It transfers the risk of failure from the contractor to the Surety, but the contractor must pay the Surety back. It is a promise that you, as an indemnitor, will indemnify, or pay the surety company back, if there are any losses on a bond you hold with them. They are an agreement between the surety company and the bond principal that ensures the surety company will be made whole.
Indemnity agreements are required for obtaining most surety bonds, but they can come in different forms. Certain kinds of indemnity agreements, like the general indemnity agreements, are useful for companies that buy bonds often or in many different states and municipalities. General indemnity agreements are generally longer than other kinds of indemnity agreements. Indemnity Agreements, Explained: Part 2 will focus on general indemnity agreements and attempt to explain them thoroughly.
As defined above, indemnitors sign the indemnity agreement. Named indemnitors help protect the surety company from loss because they are to bear the financial burden of paying the surety company back if they screw up. Indemnitors, through indemnity agreements, are legally bound to pay the surety company back. So, how are indemnitors chosen?
Well first, if the bond principal must be an indemnitor. If the bond principal is a company or entity, the owner of that company or entity must be an indemnitor. From there, additional indemnitors are generally people who have a vested financial, material or beneficial interest in the company trying to obtain the bond. The bond principal must always sign as an indemnitor. If the bond principal is a person, he or she must sign the indemnity, as well as his or her spouse. If the bond principal has a business partner(s), they may have to sign too. If the bond principal is an entity (business, corporation, LLC, etc), more people usually have to be indemnitors. As a general rule of thumb, if the bond principal is an entity, any person or trust or spouse of any person or trust owner with 10% controlling interest will have to sign as an indemnitor.
There are a lot of exceptions as to who will sign the Indemnity agreement. Surety companies use discretion on who they have sign the document. While many surety companies use 10% controlling interest of a business as a guideline for being an indemnitor, it is certainly not absolute. For example, if there is a business that needs a bond with a person who has 5% controlling interest of the business and another with 95% controlling interest. If the bond they are seeking is for the person with 5% controlling interest, or if that person’s share of the company is particularly valuable, that person may have to be an indemnitor as well.
Surety companies require indemnity agreements to ensure they are paid by the bond principal after they settle a loss on the bond. Indemnity agreements, especially long form general indemnity agreements, give surety companies extended rights and protection. Indemnity agreements protect a Surety from financial harm. Indemnity agreements ensure that there are people who are liable to pay the surety company back. They are a bit like cosigners on a loan. When there is a loss on the bond and the surety company pays it, if the bond principal does not pay the surety company back, then the financial responsibility falls to the indemnitors. This agreement ensures payment from someone involved with the bond principal and it gives the surety company power and security.