Surety bonds play a crucial role in boosting infrastructure development. Recently, the Ministry for Road Transport & Highways (MORTH) requested the Insurance Regulatory and Development Authority (IRDAI) to develop a model product on Surety Bonds in consultation with general insurers. The ministry highlighted the necessity for amendments to the Indian Contract Act and the Insolvency and Bankruptcy Code (IBC) to put Surety Bonds on par with bank guarantees.
Understanding Surety Bond
A surety bond is a written agreement ensuring compliance, payment, or performance of a specific act. It involves three parties: the Principal, who purchases the bond and undertakes the obligation; the Surety, being an insurance or surety company that guarantees the obligation will be carried out; and the Obligee, who requires and often benefits from the surety bond. These bonds are generally sponsored by insurance companies on behalf of contractors for project-awarding entities.
Aims and Benefits
Primarily aimed at infrastructure development, Surety bonds help reduce indirect costs for suppliers and work-contractors. They protect beneficiaries against acts or events that might impact the underlying obligations of the principal by assuring performance of various obligations, ranging from construction contracts to commercial undertakings, providing an alternate to bank guarantees.
Issues Encountered with Surety Bonds
Despite its potentials, Surety bonds pose some challenges. As they are a new concept, insurance companies in India lack the necessary expertise in risk assessment for such businesses. There’s also no clarity on pricing, the recourse available against defaulting contractors and reinsurance options, thus hampering the development of surety-related expertise and discouraging insurers from this business class.
Role in Infrastructure Development
The development of rules for surety contracts could address the substantial liquidity and funding needs of the infrastructure sector. It promotes equitable opportunities for large, mid and small contractors by generating an alternative to bank guarantees for construction projects. It also fosters better working capital management and reduces the requirement of collateral by construction companies while enabling risk sharing with financial institutions.
IRDAI Guidelines on Surety Bonds
The newly introduced IRDAI (Surety Insurance Contracts) Guidelines, 2022 have laid down several norms for surety insurance policies. They include provisions for contract bonds such as Bid Bonds, Performance Bonds, Advance Payment Bonds and Retention Money, offering protection and assurance in various stages of contractual obligations.
Common Types of Surety Bonds
Bid Bonds provide financial protection to an obligee if a bidder is awarded a contract but fails to sign it or provide required performance and payment bonds. Performance Bond assures that the obligee will be protected if the principal or contractor fails to perform the contracted work. Advance Payment Bond promises to pay the outstanding balance of the advance payment if the contractor fails to fulfill the contract specifications. Retention Money is a part of the payable amount to the contractor, which is retained and payable at the end after successful completion of the contract.
Surety bonds play a significant role in fostering infrastructure development by reducing indirect costs and ensuring performance of obligations. However, some challenges need to be addressed for their effective implementation in India.
