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Indemnity Bond: When and How is it Used?

Indemnity bonds are instruments used to create an agreement between two parties, especially in cases of borrowing money; financial advisors can help in understanding how to safeguard investments using indemnity bonds.

Indemnity Bonds or Surety Bonds are legal tenders that create an obligation for one party to pay the other. It is quite a specific type of bond that can be used in various instances but is primarily being used when someone is borrowing money from another. Read on to learn more about indemnity bonds and all you need to know about it.

Definitions

Indemnity: The word indemnity means security or protection against a financial liability. It generally occurs as a contractual agreement and is made between parties, where one party agrees to remunerations for the damages and loss faced by the other. In corporate law, if the company is sued or suffers damages, an indemnity agreement frees Board Directors and company executives from having to undertake any personal liability. As per Section 124 of the Indian Contract Act, 1872 a contract of indemnity can be defined as ‘a contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person, is called a contract of indemnity.’

Bond: It means security of any kind that has certain terms that must be adhered to and obligations that must be performed as part of a commitment legalized by a license, a permit, a contract or other similar legal drafts.

Indemnity Bond: An indemnity bond intends to reimburse any actual or claimed loss caused by the issuer’s or another person’s conduct. In case a principal fails to perform according to the standards agreed upon between the obligee and the principal, an indemnity bond acts as a security for the loss the obligee has suffered.
 

Where is Indemnity Bond Used?

A contractual agreement between two parties where one is willing to pay for the damages or loss caused by another is known as an indemnity bond. In other words, Indemnity Bond is a pact agreeing to indemnify the loss that may occur in future.

  • Indemnity bonds are commonly found to be agreements between an individual and a business. However, it also applies on a much wider scale and may be involved in the relationships between businesses and government or between governments of two or more countries.
  • Indemnity may be referred to as an exemption from having to pay for loss and is a comprehensive form of insurance compensation for damages or loss. In legal terms, it may also refer to an exemption from liability for damages. Thus, it is extremely important to have a good understanding of the indemnity bond terms.
  • There may be severe consequences for any lack of awareness, which, in turn, damage the reputation of the company if it rejects the idea of bearing the costs for the claim. In addition, the company may be termed as incompetent and unprofessional as a result of this.
  • Failing to pay claims may result in bankruptcy or lead to legal actions.


Features of Indemnity Bond

The indemnity bond may be express or implied.

  • When a person promises to compensate the other in express, it is known as an express promise.
  • When the conduct of the promisor displays their intention to indemnify the other from loss, it is known as an implied promise.
Note: Contract of limitation entails a limitation wherein Section 124 of the Indian Contract Act, 1872, only protects the express promise of indemnity.

Irrespective of whether the interpretive research gloss is accurate or not, Indian law has identified and recognized implied indemnities.

  1. Good Faith: Such agreements depend on mutual trust/good faith between two parties.
  2. Covers ONLY the Actual Loss: The agreement only covers the actual loss that may be caused by the promisor or any other person. It must be noted that the agreement only covers the loss caused by events stated in the contract. The event stated in the contract must happen for the agreement to be valid and applicable.
  3. Consideration Must Be Lawful: The consideration and objective of the indemnity bond must be legal.


Advantages of Indemnity Bonds

  • It can be structured to cover any type of expected loss. Both parties involved in the contract are familiar with what amount shall be paid and under what circumstances, i.e., liquidated sum.
  • This bond aims to protect one party against losses that occurred due to the principal’s failure to meet the obligations.
  • Also known as surety bonds, indemnity bonds are a part of the entire world of businesses. If there wasn’t a system that assured payment and acted as security in case one of the parties in a contract fails to pay, there wouldn’t be any commerce or business possible. An indemnity bond is created to safeguard the obligee from the principal against the potential breach of contract. It is an assurance by a guarantor to pay the obligee a specific amount if the terms of the contract are not fulfilled and/or breached. The purpose of indemnity bonds is to guarantee financial reimbursement for any damage faced due to the illegal actions of the other party that is bonded through the agreement.
  • The principal signs an agreement to indemnify with the surety provider as part of getting an indemnity bond. According to this, in case of bond claims, the entire financial responsibility belongs to them rather than the surety.


Indemnity Bond for Property

Post finalizing a property deal, the surety company signs an indemnity bond. The surety company will demand the bonded contractor to complete a project. For example, if the bonded contractor is not able to complete the project, the surety company can work with another contractor and claim the difference in amount from the contractor that failed to deliver.


Need for Indemnity Bonds

Indemnity bonds are majorly required for instances of borrowing money and property transfers. However, some other situations that it is needed in as well are:

  • Borrowing funds from banks.
  • For the release of payment.
  • In the event of losing a fixed deposit receipt.
  • Transfer of property to legal heirs.
  • In cases of death claims.
  • Transfer of electricity connection.
  • Government Indemnity schemes.

These bonds are enforced to cater legal protection to the parties involved in the agreement. Projects progress professionally and ethically by signing indemnity bonds.

When is an Indemnity Bond imposed?

In the event of an infringement of the terms in the agreement, the indemnity bond is imposed. A party may only face liability in case of contract breach, where the party under fault is responsible to compensate the other party as per the damages caused.


Difference between Affidavit and Indemnity Bond?

 
Affidavit Indemnity Bond
An affidavit is like a statement of oath that ensures the individual is telling the truth and not hiding anything at all. The document states that no material information or knowledge is hidden by the parties involved. Indemnity Bond is a document providing security to a party that will be given compensation in case the contract is breached. The compensation may be monetary or in any medium, as agreed upon in the bond.
 

Common Types of Indemnity Bond Used in General Corporate Transactions

  • Besides insurance policies, Indemnity Bonds are drawn between employer and employee as well. The bond certifies that the employee will serve the employer for a specific period. If the contract is breached by the employee and they leave before the assured term is completed, they will be entitled to pay the employer monetary compensation.
  • Those who have lost a Share Certificate also create an indemnity bond. The bond states the genuine loss of Share Certificate and requests for a New Share Certificate to be processed. The bond exempts the applicant of all the costs related to issuing a New Share Certificate.
  • When a company or an educational institution wants to apply to alter the basic details of a student, an indemnity bond may be provided to them to indemnify any loss that may occur as a setback of changing the details. Indemnity bonds may be signed by Government authorities and independent contractors.

Based on the variety of transactions made, these indemnity bonds can be enforced between numerous parties.

Stamping of Indemnity Bonds

According to the Indian Stamp Act, 1899, the stamp duty must be paid in case of Indemnity Bonds.

Conclusion

Laws related to indemnity bonds have been derived from the common English law in a lot of ways and evolved in their own way. The bond safeguards a party against the loss that may be incurred due to the failure of the principal’s ability to fulfill the obligations of the agreement. However, enforcing indemnity bonds in employment agreements is still full of disputes.

Employers must take a different route to retain their employees for longer periods. Awarding benefits like incentives and retention bonuses are a few ways to retain employees and ensure they work for a longer period with the organization.

 

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