What Is an Indemnity Bond?

Surety bonds are instruments that create a legal obligation for one party to pay another. An indemnity bond is a specific type of surety bond that’s often used in situations where someone is borrowing money. However, you might also be required to purchase an indemnity bond if you lose a cashier’s check and need to get a replacement from the bank.

A financial advisor can help you figure out when to get an indemnity bond to protect your investment.

Indemnity Bonds, Explained

An indemnity bond is a surety bond that creates a financial contract between two parties. Indemnity bonds are designed to ensure that if one party doesn’t uphold their obligations, the other party can seek a remedy.

In a sense, an indemnity bond is similar to an insurance policy. Rather than insuring a piece of property or someone’s life, however, indemnity bonds convey a right to collect financial compensation if one party defaults on their responsibilities in a legally binding agreement.

How Does an Indemnity Bond Work?

An indemnity bond works by guaranteeing to indemnify and reimburse someone for financial losses they experience when the other party to the bond defaults on their responsibilities or obligations. In other words, they protect one party against wrongdoing by the other party.

In a typical indemnity bond transaction, one party is identified as the principal while the other is the obligee. The principal is the party that’s required to obtain the bond. The obligee, meanwhile, is the party that can be indemnified or recompensed if the principal fails to follow through on their responsibilities.

If the obligee, believes that the principal has fallen short or has otherwise defaulted on the contract, they can file a claim against the bond. Should it be determined that the principal has failed to keep their part of the agreement, they’re required to pay the obligee, up to the full bonded amount.

When Do You Need an Indemnity Bond?

Indemnity bonds may be necessary in situations where there’s an agreement between two parties to exchange goods or services for money. They may be required for certain types of businesses, depending on state and local laws.

Here are four common scenarios where you might be subject to an indemnity bond:

Buying a car. Auto dealerships may be required by state law to issue indemnity bonds when selling vehicles. In that scenario, the bond would be designed to protect you against fraudulent practices or breaches of contract.
Buying a home. State laws can also require mortgage brokers to issue indemnity bonds when working with home buyers or sellers. Similar to indemnity bonds for car dealerships, these bonds are intended to shield consumers from fraudulent behavior.
Building or renovating a home. If you’re planning to build or renovate a home, the contractor you work with may be required to have an indemnity bond. Again, the purpose of the bond is to prevent you from being harmed financially by fraud or default on the part of the contractor.
Taking out loans. Indemnity bonds can come into play when you borrow money as well. For example, if you’re getting a mortgage there may be an indemnity bond requirement that serves to protect the lender against default. Business loans and personal loans could also require an indemnity bond.

Business owners may also use indemnity bonds to protect their commercial interests in certain types of transactions. Indemnity bonds can be used in situations where a business owner is leasing equipment, vehicles or property. They may also use indemnity bonds when establishing licensing agreements or contracts with their suppliers.

What Is an Indemnity Bond for Cashier’s Checks?

Indemnity bonds can have another use if you lose a cashier’s check. A cashier’s check is an official check that’s drawn on the bank’s funds, not yours. You might obtain a cashier’s check if you’re buying something and you can’t or don’t want to use a personal check, credit card or cash to pay. For example, you might get a cashier’s check if you’re buying a car or an ATV from someone you don’t know very well.

If you lose a cashier’s check that you purchased, you can ask the bank to replace it. But the bank might require you to get an indemnity bond for the amount of the check first. The indemnity bond guarantees that you, not the bank, will be liable for losses if someone finds the lost check and cashes it. In that case, the bank would be out the money for both checks.

Should you lose a cashier’s check and need to purchase an indemnity bond, you’ll need to find an insurance company that’s willing to sell one to you. You could ask your current insurance agent for help in obtaining an indemnity bond.

Keep in mind that the bank may not replace a lost cashier’s check right away. There may be a holding period or waiting period before you can get a replacement check.

What happens if you lose a cashier’s check that someone else gave to you? In that case, you could ask the person who gave you the check to replace it. If they’re unwilling to do so, you could ask the bank that issued the check for a replacement though again, you might need to provide an indemnity bond.

How to Buy an Indemnity Bond

As mentioned, indemnity bonds are sold through insurance companies, though not all insurers offer them. You may need to spend some time searching online to find a reputable company that offers indemnity bonds for sale.

Once you find an insurer, you’ll need to fill out an application for the indemnity bond. The application is designed to gauge your overall risk level and may involve a background check. The insurance company may also review your credit reports and scores to assess your creditworthiness.

If you’re approved for an indemnity bond and the other party involved agrees to the terms, you’ll need to pay a premium to obtain the bond. The premium is typically a percentage of the amount covered by the bond. Depending on the bond issuer and your creditworthiness, you may pay a premium ranging from 1% to 5%.

Bottom Line

Indemnity bonds are an important financial instrument that can help to prevent one party from losses at the hands of another. If you own a home, buy a car or pay contractors for repairs, it’s possible that you’ve been subject to an indemnity bond at some point. And should you lose a cashier’s check, you can talk to your bank about whether an indemnity bond is necessary to replace it.

Financial Planning Tips

Consider talking to your financial advisor about when you may or may not need an indemnity bond to complete a financial transaction for yourself or for a business you own. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Indemnity bonds are just one type of surety bond that you may encounter. A probate bond is another kind of surety bond that you may deal with when managing probate for a deceased loved one. A probate bond may be required if you’re acting as the administrator or executor of an estate that has outstanding debts. In that scenario, a probate bond serves as a form of protection for the deceased person’s heirs. If you’ve been asked to act as executor for someone, it’s important to understand what your obligations are with regard to probate bonds.