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Understanding Indemnity

Understanding indemnity agreements is important for any contractor performing bonded work.

Indemnity plays a key role in protecting taxpayer money and the project owner from poorly performed work; making sure subcontractors and suppliers get paid; and perhaps most importantly, keeping the premiums paid for surety protection very low. Without indemnity, sureties likely would charge much more for bonds.

Although the surety is indemnified by the contractor under law, the General Indemnity Agreement (GIA) not only puts this in writing, but it also allows owners of the company, or other individuals, to help the contractor qualify for surety bonds or larger bonds than the contractor would get alone.

Personal indemnity allows the surety to consider the owner’s financial situation in underwriting the bonds and helps assure the surety that funds will not be diverted from the bonded project to unbonded projects. The GIA also spells out how claims will be handled. Contractors and their agents should check the claims handling reputation of any surety company and build relationships with the good ones.

The Basics

A surety indemnity agreement is an agreement between the contractor and the surety, and other individuals and the surety, stating the surety company will be indemnified if it pays out a claim on the bond, including legal fees.

In simple terms: a surety company issues a bond that guarantees the performance of a contractor and guarantees the contractor will pay subcontractors and suppliers. But, the contractor remains liable for these obligations. If the surety company must perform its duty and pay claims or replace the contractor, the contractor is required to reimburse the surety company for the full amount of the claims paid.

Some experts call surety bonding “borrowing the balance sheet of the surety company for the purpose of a contract.”

Why Indemnify?

The indemnity agreement is a clear and unambiguous way to define the obligations of the contractor and indemnitors. The cost of a bond is a very low price to pay for the surety to step up and promise to cover the entire cost of a multimillion-dollar project if the contractor doesn’t perform. This is possible because the surety has underwritten the case to make sure the construction company and any indemnitors have the wherewithal to repay the surety if the need arises. An indemnity agreement is good for the contractors that can obtain bonds larger than if there were no indemnity, and it’s good for the owners that pay less for the bonds.

Negotiate Terms Or As-Is

Construction attorneys often are concerned the indemnity agreement might allow the surety to step in at any time and take over a project, including the contract funds. This would never be in the surety’s best interest. Lawyers also sometimes are concerned that the surety has the power to pay claims without consulting the contractor, and therefore, they try to negotiate the terms of the indemnity agreement, asking for conditions on the indemnity such as, “in case of default” or “in case of termination.”

Again, this wouldn’t be in the interest of the surety; a surety always needs to gather information about any claim. In special circumstances, surety companies will consider negotiating some of the language of the GIA with financially strong contractors that have good track records for meeting their obligations.

Sureties prefer the agreement to be signed as-is, allowing them to fully perform their duties. The bond principal and any indemnitors have to understand that the surety cannot be their rubber stamp if a claim is made. Just as the existence of the bonds helped the principal qualify for the contract, the existence of the indemnity agreement helped the principal qualify for the bonds.

No one, least of all the surety, wants to see the contractor fail. The surety wants the contractor to be successful and meet its obligations.

Communication Is The Key

Communication is how all parties can work together for a win-win. No surety should unreasonably pay claims without first communicating with the contractor and the contractor’s agent. No surety should take over a project from a contractor and incur the costs to complete it successfully if it can stop problems while they are still manageable.

A qualified surety company will always work hard to help solve any problems and communicate with all parties throughout the project. The GIA helps set out the process for everyone to stand behind the contractor and the work.

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