Indemnity agreements are a standard of the surety bond industry. Bonding companies usually require the president to sign on behalf of the company, all owners with over 5% ownership to sign personally, and the owners’ spouses to sign personally. In this article, we will learn why the bonding companies require all of these people to indemnify, what the agreements usually include, why they aren’t as scary as they appear to be, and the alternatives to bonds and indemnification.
Each bonding company has different language for their indemnity agreement. In general, the agreements all have very similar terms, but just use different language to state them. An indemnity agreement states that the principal is responsible for reimbursement for claims and the attorney fees associated with them. One must recall that surety bonds are not like insurance. The principal is in no way protected, the bond is required to protect the public. Claims are to be paid by the principal.
Often, a principal states they do not want their spouses to sign personally. They make the argument that they created the corporation to protect themselves personally, which is exactly why the surety wants spouses to sign. Unfortunately, spousal indemnity is rarely waived, even for the strongest of accounts. The bonding companies do have reasons for the requirement. For one, they don’t want corporate assets to be transferred to a spouse after a claim. To understand why they want spousal indemnity, one must recall what a surety bond is, a guarantee that a company will operate per the terms of the bond. Bonding companies can underwrite using every piece of financial information available, but why would they feel comfortable bonding a company if the owner’s spouse doesn’t feel comfortable doing the same?
A common fear among indemnifiers is that a surety is going to take their home. Bonding companies are not in the business of kicking people out of their homes. Homes are a last resort when it comes to collecting payment on a bond claim. The surety will first look to the company listed on the bond for repayment. If the company is unable to pay for the claim and associated legal fees then the surety will attempt to collect from the individual owners. It is rare that a surety will attempt to take ownership of an individuals home. For one, the surety will not make a good name for themselves taking ownership people’s homes just to make year end profits higher. In many cases, the surety has no right to pursue ownership of an individuals home, due to state laws prohibiting such action.
It is extremely rare for a surety to waive any of the above requirements. Usually, the only way to do so is to provide 100% collateral. Providing 100% collateral is a poor alternative, as it would be better to post a letter of credit instead (if an ILOC is acceptable to the obligee). Directly posting a letter of credit would alleviate the any indemnification worries and would be roughly the same cost of a bond. The downfall of a letter of credit is that you have to tie up a good amount of capital. One must also remember, that bonding companies typically only write bonds that have aggregate limits. Therefore, the claim amount can not exceed what one would lose with a letter of credit. When one looks at the alternative, spousal indemnification does not look so bad.
At the end of the day, the ball is in the court of the bonding companies. They are guaranteeing the bond, so they get to make the terms of issuance. Personal and spousal indemnification makes more sense if you look at it from the bonding companies point of view. If the applicant and their spouse can’t guarantee the company, why would they want to? The alternatives to bonds only tie up capital and do not low the amount of liability. In a perfect world the bonding companies would not need spousal indemnification. Unfortunately, bond claims are a real thing and the sureties need all the assurance they can get that there will not be a claim on a bond.