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An indemnity bond or a surety bond protects the person or company holding the bond from financial loss. In other words, the holder of the bond has the right to receive money from a company that agrees to protect the holder from losing money. Indemnity bond is a catchall term that includes many types of bonds such as construction bonds, fidelity bonds, license bonds and other bonds that function in the same way. Before it sells a bond, a surety company requires the person or company buying a bond to meet specific qualifications such as having good credit, business experience, or financial resources.
The law treats an indemnity bond as though it is a contract involving three parties. The technical names for each party are a principal, an obligee, and a surety. The principal is the person or company buying the bond, the surety is the company that sells the bond, and the obligee is the person that holds the benefit or the guarantee from the bond. The indemnity bond guarantees that the surety company pays money to the obligee, if the principal does not fulfill an obligation to the obligee. Some bonds may require the surety to perform the obligation the principal failed to complete by hiring someone else to finish a job.
Another example is a bank that requires a homebuyer to purchase an indemnity bond. In this case, the homebuyer is the principal and the bank is the obligee. The homebuyer goes to a surety company and buys the indemnity bond. If the homebuyer fails to pay the bank, the bank forecloses on the home and sells it to recover the money it loaned. If the money received does not cover the entire loan amount, the surety company pays the bank the difference.
A surety company sells several types of bonds and it investigates whoever is buying the bond. The surety does this because if it pays a claim on a bond, the surety wants to recover its money from the buyer. Typically, a surety wants a buyer to have good credit or to have resources it can pursue through a lawsuit. As long as the surety is confident that it can recover its money, then it will likely sell an indemnity bond.
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