Indemnity for Surety Bonds
Updated: Jun 8, 2021
One of the most common questions in surety is regarding indemnity, particularly spousal indemnity. If a contractor is new to bonding, and suddenly the owner of the project is requiring a bond, indemnity is one of the biggest surprises. We would like to provide a clear understanding of what and why indemnity is necessary.
A surety bond is a three-party agreement between the contractor, the surety, and the project owner that guarantees the contractor will complete its bonded obligation to the owner. If the contractor does not complete the project to the extent of the contract executed, the surety will step in and make sure that the project is completed and is legally entitled to pursue repayment of costs associated in doing so from the contractor.
The indemnity agreement, which is required before a bond is issued, is the avenue in which the surety can attempt to recoup their losses from a claim.
This contract is between the contractor (Indemnitor) and the surety (indemnitee) in which the contractor assumes full liability, giving the surety protection in the event of a claim being placed on the bond.
All Indemnitors assume the liability of any losses or expenses the surety pays as a result of the claim against the bond. The losses will include any cost associated with the completion of the project and all cost necessary to investigate the claim itself. Very important to note is the sureties only interest is to be made whole for any and all outgoing costs. They are not trying to make additional money beyond their cost.
Therefore a surety requires that an indemnity agreement be signed and delivered before the bond is issued. In addition, the indemnity will apply to all bonds issued by the surety for that contractor. Although there is a variance in how indemnity agreements read from one surety to another, as a rule, the language of their indemnity is not negotiable.
Corporate, as well as personal indemnity, is required for both owner and spouses by all sureties. When this is communicated to contractors, often they ask, “Why would my spouse have to indemnify, particularly if she doesn’t own a part of the company?”
It may seem unfair, but if you think about what causes a contractor to default on a job, it’s often from insolvency or bankruptcy. When that occurs, any remaining assets are subject to claims by multiple creditors, not just the surety. In order to protect its interests, the surety requires a personal guarantee that the losses will be repaid by the contractor.
In addition, spousal indemnity prevents a contractor faced with bankruptcy from transferring assets to their spouse to attempt to protect those assets that would have been used to repay the surety for any losses incurred. In the case of a divorce by the contractor, having the spouse’s signature also prevents assets pledged on bonded projects from going to an ex-spouse in a divorce settlement.
What’s in the agreement
It is always important to understand the conditions of anything you sign individually, corporately, or both. Even though it’s a standard part of surety bonding, contractors should carefully review an indemnity agreement. Because an indemnity agreement gives a number of enforceable rights to the surety, be sure to clearly understand those and if you do not, engage an attorney, before signing. Among the provisions you should be familiar with:
Indemnification. Most agreements contain broad language holding harmless and indemnifying the surety from any and all liability, loss, costs, damages, fees, and other expenses incurred if there is a claim on the bond.
Right to enforce. The surety has the right to sue if the contractor fails to comply with its obligations. This could include failure to deliver collateral, hold contract funds, and make books and records available.
Right to settle. The surety has the sole right to decide whether claims against the bond will be paid, settled, or defended.
Collateral deposit. The surety has the right to demand collateral from the contractor to cover potential liability.
Assignment. The surety has certain rights to the contractor’s funds, equipment, and materials if there is a claim on the bond or a default.
Right to examine books. Most agreements give the surety the right to examine the contractor’s books and records. This is the reason to always keep your books inline