An indemnity bond is, at its basic level, a type of insurance policy that ensures one party to a contract will perform as required. Indemnity bonds, also referred to as surety bonds, are used across the business world. Commerce would not flow if there wasn't some mechanism in place to assure payment if one of the parties to a contract failed to act.
An indemnity bond is an insurance contract intended to reimburse the holder of the bond for any loss caused by the named party's conduct. There are usually three parties to an indemnity bond: the principal (the person who will receive the money in the case of a breach), the obligor (the person who purchases the indemnity bond as security for performance) and a third-party guarantor, usually a bank that, for a premium or fee, assumes the risk to pay the face value of the indemnity bond should the obligor fail to perform the terms of the contract with the principal.
Indemnity bonds are used worldwide to guarantee payment. There are innumerable examples where businesses require indemnity bonds. For example, A had a stock certificate registered in his name with X company, but when the company required all paper certificates to be returned to the company in exchange for electronic registration, A could not find the paper certificate. Before X company or its broker would issue the electronic registration, X could require A to purchase an indemnity bond so that if the paper certificate were presented later for payment, the bond would cover the double payment of the value of the paper certificate.
To execute or redeem an indemnity bond, the claimant or principal must comply with the terms of the indemnity bond. In most cases, the claimant must provide written notice that the obligor has failed to perform under the contract, and the claimant is looking to the guarantor or issuer of the indemnity bond for payment. The guarantor will likely contact the obligor to determine the problem and many times attempt to work out an arrangement beneficial to all parties. If this cannot be done, the guarantor, after verifying the obligor's failures, will pay the bond.
Indemnity bonds can be purchased from most financial institutions, insurance companies and other surety specialists. If a business partner or client requires you to purchase an indemnity bond, consult with an attorney to understand fully your obligations and the terms under which your partner or client can redeem the indemnity bond. When you are ready to purchase the bond, look first to your trusted financial adviser for a recommendation, or consult with your local bank.