Indemnity bond

From CEOpedia | Management online

Indemnity bond is "a bond that promises to indemnify the obligee against losses stemming from the principal's failure to perform" (BusinessDictionary 2018).

What exactly contain indemnity bond

First of all, an indemnity bond is a kind of insurance policy that guarantee an appropriate performance of a contract. Indemnity bonds are common in a business. They are used as a mechanism to guarantee payment. An indemnity bond aims to repay the holder of the bond for a loss or expense. According to Ch. Morin, "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" (Ch. Morin 2017). Payment is guaranteed due to indemnity bonds.

Practical application indemnity bond in Enterprise

There are many situations in which businesses need them. For instance, somebody chartered a stock certificate with a company. However, the company needed documents in paper instead of electronic registration and they were not able to deliver the paper certificate. In this situation, before the company's broker could surrender the electronic registration, the company was able to demand purchasing an indemnity bond. When the paper documents were delivered later, the indemnity bond could pick up the tab of the worth of the paper certificate (Ch. Morin 2017).

There are some common kinds of indemnity bonds in business world. As J. Gautam pointed out, "apart from a General Insurance Policy, an Indemnity Bond is also drawn between employer and an employee, where an employee undertakes to serve the employer for a specific period of time and if he leaves the services before completion of the said term, then monetary compensation has to be paid" (J.Gautam 2018).

In case when somebody cannot find a share certificate, an indemnity bond is needed. Because the indemnity bond includes information confirming the lost of the share certificate and at the same time it asks for issuing an new one. An indemnity bond is also drawn in situation when an educational company puts an application for alteration to effect an insurance of any loss that can appear in the sequel of the modification in the basic particulars of the company which applies. What is more, it needs to be underlined that an indemnity bond might be carried out between an independent businessman and the government (J.Gautam 2018).

With this result, an indemnity bond might be performed between a lot of parties in the business deal or action of diverse nature. There are also many ways in which an indemnity bond may be realized. When there is a possibility of the holder's loss, an indemnity bond assures compensation of costs. It needs to be underlined that an indemnity bond guarantees actions of a party in compliance with the agreement made in a contract. An indemnity bond is often demanded before replacement a legal paper which was lost, for instance a car title. In this situation, three parties take part in the agreement. According to J. Mancini," the principal is the person purchasing the bond. The obligee is the person benefiting from the bond. The surety, also referred to as a guarantor, charges a fee to assume the risk of the indemnity bond's value" (J. Mancini 2018).

For instance, there has been a loss. When somebody claims that they are the owner of another person's car falsely, the local division of motor vehicle is able to show the indemnity bond in documents that the constituent was obliged to acquired. Many divisions and banks store an indemnity bond in documents but only for some time. Observing the deadline is important, for instance some of the divisions claim that indemnity bonds are kept in documents for three years (J. Mancini 2018).

Examples of Indemnity bond

  • Performance Bond: A performance bond is a type of indemnity bond that guarantees the performance of a contract by a contractor or subcontractor. It is usually issued by a bank or an insurance company and is designed to protect the owner of the project from any losses that may arise from a contractor’s inability to complete the work according to the terms of the contract.
  • Bid Bond: A bid bond is a type of indemnity bond that is issued by a bidder to guarantee that the bidder will enter into a contract and pay any associated costs if they are awarded the contract.
  • Surety Bond: A surety bond is a type of indemnity bond that is used to guarantee that a party will fulfill its obligations. It is issued by an insurance company or bank and is typically required for certain types of contracts.
  • Fidelity Bond: A fidelity bond is a type of indemnity bond that is used to protect an employer from losses that may arise due to the dishonest or fraudulent actions of an employee. It is designed to cover losses that are not covered by traditional insurance policies.

Advantages of Indemnity bond

Indemnity bonds have a number of advantages that make them a useful tool in a variety of situations. These advantages include:

  • Financial Security - An indemnity bond provides a guarantee to an obligee that any losses stemming from the principal’s failure to perform will be reimbursed. This helps ensure that the obligee is not left in a difficult financial situation due to the principal’s negligence.
  • Timely Payment - With an indemnity bond, payment is typically made as soon as the claim is filed. This is in contrast to other forms of financial compensation, which may take longer to process.
  • Flexibility - Indemnity bonds can be tailored to fit the needs of each particular situation, which makes them a more versatile option than other financial guarantees.
  • Cost-Effective - While an indemnity bond may require an upfront payment, this cost is typically cheaper than other forms of financial protection, making it a cost-effective option.

Limitations of Indemnity bond

Indemnity bonds have limitations. These include:

  • The bond is limited to a fixed amount of money, so it may not be enough to cover all of the damages incurred by the obligee.
  • The indemnity bond does not protect the obligee from losses caused by their own negligence or misconduct.
  • The indemnity bond does not provide the obligee with any legal remedies, such as the right to sue the principal.
  • The indemnity bond does not guarantee that the principal will perform the promised duties.
  • The indemnity bond does not provide the obligee with any guarantee that the bond will be paid in the event of a dispute between the parties.

Other approaches related to Indemnity bond

An Indemnity bond is a form of contract guaranteeing to compensate an obligee for losses incurred due to the principal’s failure to perform. However, there are other approaches which can be taken to ensure the same result. These include:

  • Surety Bonds: Surety bonds are a type of financial agreement between three parties, guaranteeing that the principal fulfils their obligations.
  • Performance Bonds: Performance bonds guarantee that a contractor completes a project as outlined in the contract.
  • Financial Guarantees: This type of guarantee outlines the terms of the agreement and specifies the financial obligations of the guarantor.
  • Guarantor Agreements: A guarantor agreement guarantees a loan or other financial agreement, with the guarantor taking responsibility for settling the debt if the principal fails to do so.

In conclusion, while an Indemnity bond is one way of ensuring that an obligee will not incur any losses due to the principal’s failure to perform, there are several other approaches which can be taken to achieve the same result.

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Author: Joanna Piórkowska