What Are Indemnity Bonds?

Indemnity bonds are insurance policies that protect the holder, purchaser, and any other party to a transaction against loss occasioned by a superseding interest. The bond provides assurance that the party receiving the benefit of the transaction, usually the buyer, won’t have to give up his interest without receiving compensation if someone asserts a claim that takes precedence over his newly acquired interest. This type of bond can be used in a variety of transactions, but the commonality is the desire to provide additional insurance against an outside party interfering in the transaction.

The commercial transaction concept called buyer beware refers to the responsibility of a buyer to ensure that the seller has the legal right to sell the property at issue. For instance, if a buyer purchases stolen property from a seller that disappears afterward, the buyer would have to return the property to its rightful owner and would lose his money. The buyer’s only recourse would be against the seller, who may never be found. An indemnity bond is an insurance policy that protects the buyer in this instance by compensating him for having to return the stolen property to a person with a superseding claim.

An early example of indemnity bonds in U.S. history is bonds taken out on the purchase of slaves. If the slave was later freed by the government, the slave owner would be compensated for the loss. In a more current context, an indemnity bond would be issued in a transaction where a person was trying to sell his interest in a corporation but has lost his stock certificates. The insurance policy would protect the corporation, transfer agent, and buyer from someone showing up later with the certificates in hand and invalidating the transaction.

Another current and appropriate use of indemnity bonds is in the sale of artwork. During World War II, many works of art were stolen from institutions and individuals and never returned. Quite a few countries have passed laws that allow these prior owners to retrieve their artwork when identified, even if the piece has been subsequently sold to innocent purchasers multiple times. As a result, title to any piece of art that predates World War II can be subject to an unforeseen claim, and a bond would protect a current buyer from that type of loss.

Indemnity bonds are also used frequently in real estate transactions where the underlying mortgage is more than a certain percentage of the value of the property. If the property goes into foreclosure and is sold at a discount, the insurance policy would make up the difference between the loan amount and what the property sold for at auction. In this way, an indemnity bond is a type of surety bond, ensuring that all parties receive the benefit of their bargains.