Introduction
An indemnity bond is a legal document that contains a formal agreement that one party signs stating that he/she will be held responsible for compensating or reimbursing another party for any loss or damages that may arise as a result of an activity in which the former has engaged or in which he has agreed to participate. It is commonly known as surety bond and acts as a security that the party providing the guarantee – the obligor or principal – will perform their business commitments or, in case of default, make the required reimbursement to the beneficiary – the obligee. It is usually provided in contracts, business transactions, construction and many other fields and legal relations.
Parties Involved:
- Principal (Obligor): The party who agrees to take the responsibility of performing activities or meeting contractual agreements.
- Obligee: The party that is entitled to the benefit of the bond and who is likely to receive money if the principal is unable to perform from the surety as expected.
- Surety: The third party that is supposed to offer the bond and thus assure the performance of the principal, usually an insurance company or a bank.
When do we need indemnity bonds
The indemnity bonds are often used in the cases, when financial guarantee or insurance is needed. Here are some common scenarios in which indemnity bonds are typically needed:1.
1.Government Contracts
- Performance Bonds: Mandatory in order to ensure that the contractors finish their tasks in conformity with the project specifications.
- Payment Bonds: Make sure that you pay subcontractors and suppliers for the work done and materials supplied to you.
2. Legal and Financial Transactions
- Loan Agreements: To guarantee the repayment of loans or advances given to an entity by a creditor.
- Financial Guarantees: To ensure one is able to meet his/her financial obligations or any other obligations that have been agreed between two or more parties.
3. Property Transactions
- Title Transfers: To shield against actions within the property or to defend against any and all claims or flaws in the title of the property.
- Lease Agreements: To monitor whether or not tenants are adhering to the lease terms and conditions that have been signed between the parties.
4. Customs and Imports
- Customs Bonds: To ensure that duties and taxes are paid and regulatory measures are obeyed as a surety for the transaction.
5. Employment and Fidelity
- Fidelity Bonds: To act as umbrella coverage in order to compensate the employer in the event of the employee’s misconduct or embezzlement.
6. Construction Projects
- Contractor Bonds: To ensure the effective completion of constructions and enforcing of construction specifications.
- Maintenance Bonds: These bonds ensure that contractors will fix any flaws within the stipulated period following the construction of the public projects .
7. Legal Proceedings
- Court Orders: In order to obtain a guarantee for payment, compensation, or performance of orders issued by the court.
- Bail Bonds: For production of a defendant whenever an appearance is required in a court of law.
8. Business Transactions
- Indemnification Agreements: As an insurance against loss which one party may suffer through the conduct of the other party or lack of it.
- Partnership Agreements: For the protection of the partners in business incorporation.
9. Insurance Claims
- Claim Indemnity Bonds: It pertains to the practice of retaining a portion of the monies paid out by insurance companies on settled claims to protect the insurance companies from further claims relating to the same incident.
10. Public Utilities and Services
- Service Contracts: To safeguard the payment for products in utilities or services offered to organisations or consumers.
Legislations governing indemnity bonds in India
There is no existing law in India for any composite definition of an indemnity bond. Indemnity bonds in India are subject to the provisions of two pieces of legislation: The two important legal statutes that govern contracts are the Indian Contract Act, 1872 and the Indian Stamp Act, 1899. While the contracts related to indemnity have been defined in the Indian Contract Act, 1872 different bonds along with the stamp duties have been discussed in the latter Act. Section 15 of the Government Securities Act, 2006 was enacted to permit the bank to enter an indemnity bond with one or more sureties.
Indemnity bonds fall under the category of contingent contract according to the Section 31. A contingent contract is that kind of contract that becomes effective if the event that is stated in the contract happens. If not it gets void.
A contingent contract can only be enforced by law when the uncertain future event has occurred as provided in the said contract. This cannot be enforced before then at all. However, if the event does not occur or if the occurrence of the event becomes impossible, the same can never be compelled or enforced in terms of Section 32 and Section 33 of the said Act.
In the case of indemnity bonds, they are only valid if the obligee suffered loss or harm. In a situation where the obligee is not affected by the principal, he or she cannot benefit from an indemnity bond.
It is important to note here that the enforcement of indemnity bonds in India.
An indemnity bond becomes valid only if there is a breach of the contract under Section 73 and Section 74 of the Indian Contract Act of 1872. The breach gives rise to a legal duty upon the part of the principal to make reparation or pay damages to the obligee, while entitlement to compensation arises for the obligee.
- The Indian Stamp Act, 1899
Unfortunately, there is no definition of an indemnity bond given under the Indian Stamp Act, 1899. Even the courts in India rely on the provision of the Indian Contract Act, 1872 to apply the indemnity bonds under the Indian Stamp Duty Act, 1899.
However, it defines bonds under section 2(5) of the companies act. In connection with stamp duty, the term indemnity bond has been referred under Schedule 1, No. 34 dealing with stamp duty payable on legal instruments, but there is no definition of this term. Rules regarding stamp duty and how it has to be paid in regulation to an indemnity bond are laid down under Section 29.
How Indemnity bond works
An indemnity bond is a kind of financial security wherein in the event of loss or damage arising from the negligence of a party in a contractual or other legally binding relationship, then the party is required to compensate for the same. Here’s a step-by-step explanation of how it works:Here’s a step-by-step explanation of how it works:
- Bond Issuance:
The principal enters into an application with a surety company to be provided with an indemnity bond.
The surety company makes an assessment on the financial credit strength of the principal, and the risk factor.
The principal forwards a premium to the surety company, and that creates the bond in question.
- Guarantee Provided by the Bond:
It serves as a guarantee as to the conduct of the principal (for instance to finish the construction works, to pay sub-contractors, or not embezzle money).
In the event the principal neglects his/her duties as outlined in the bond, the obligee has grounds for getting back their money through the bond.
- Making a Claim:
The obligee can make a claim to the surety company if he/she feels that the principal has breached the cited obligations.
The surety company examines the claim with a view of verifying the truth of the claim as presented.
- Claim Payment:
If the claim is true, the surety company reimburses the obligee with the amount stated as the bond penal sum.
This compensation focuses on reimbursing the obligee for the losses or damages which may have been occasioned by the non-performance of the principal.
- Indemnification of the Surety:
Subsequent to settlement of the claim, the surety company demands indemnification from the principal.
The principal is supposed to reimburse the surety in case it pays out some sum of money, together with other related legal and administrative expenses.
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