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Surety Bonds in India – Coverage, Types and Exclusions

Today India is a fast-growing economy on its way to reach $5 trillion of GDP. Consequently, India has been witnessing aggressive infrastructure development in recent years and India is expected to becom the third largest. These infrastructure projects require the contractor to provide financial guarantees to project owners, typically the government.

Traditionally, the contractors have been using bank guarantees to provide financial guarantees. However, the disadvantage being that it locks up significant capital that could have been used for the construction projects.

It is for this purpose that Surety Bond Insurance was recently launched in India. We will discuss the various types of surety bonds available, the process of obtaining and renewing them, and the advantages they offer over bank guarantees.

So, whether you're a seasoned contractor or just starting out, read on to learn more about how surety bonds can help alleviate some of the pain points associated with infrastructure projects in India.

Surety Bonds in India – Coverage, Types and Exclusions

What is Surety Bond Insurance?

Surety Bond is a form of financial credit known as Bond Guarantee. Surety bonds are legally enforceable three-party contract that guarantee performance and/or payment. Surety Bonds are used to guarantee the performance of a contractor, supplier, or other party in a business transaction.

Surety Bond Insurance always involves 3 parties:

  1. The first party is the Principal who is going to be the beneficiary, if the Surety Bond is called upon;
  2. Second Party is the Contractor 
  3. The final party is the Surety Provider. The Surety Provider is basically the Surety Bond Insurance Company.

Surety bonds can be used as a substitute for Bank Guarantees.

How does a Surety Bond work?

A Surety Bond protects the Principal, the party to whom the bond amount is going to be paid, in the event of a default against the losses that result from the Contractor’s failure to the perform his obligations.

Surety Bonds are designed to ensure that the Contractors act in accordance with certain laws. Surety Bonds provide the Principal with the financial guarantee that the Contract and other business deals will be completed in accordance with the agreed mutual terms between the Principal and the Contractor.  So, Contractor’s Obligations are specified in the contract which is signed between the Principal and the Contractor.

If the Contractor defaults on those terms, the harmed Principal can make a claim on the Surety Bond Insurance to recover the losses incurred and the claim payment would be made to the Principal under the Surety Bond Insurance. So, the Surety Bond Insurance Company assumes the liability if the Contractor cannot fulfil his contractual obligations

The Surety Bond Insurance Company, then has the right to the reimbursement and subrogation from the Contractor in the case of a paid loss or claim.

What are the different forms of Surety Bonds in India?

There are two forms of Surety Bonds in India:

  • Unconditional Form: In an Unconditional Form of Surety Bond, any default leading to a liability on the principal debtor, that is the Contractor, to make a payment under the contract shall be settled on demand. The Unconditional Form of Surety Bond Insurance is very similar to a Bank Guarantee. A Bank Guarantees is payable on demand. So, if the Principal says there is a default and invokes the bank guarantee bank, then the bank has to the Guarantee Amount on demand. Similarly, under the Unconditional Form of Surety Bond, the Surety Bond would be submitted to Surety Bond Insurance Company by the Principal, the Insurance Company needs to make the claim payment without any questions.
  • Conditional Form: In a conditional form of Surety Bond Insurance, any default leading to liability on the Principal Debtor, that is the contractor, to make a payment under the contract, is settled only at the discretion of the Surety Insurer based on the facts and circumstances.

So, the difference is that while the underlying contract remains the same, and even the definition of default is the same, in a Conditional Form of Surety Bond Insurance, the Surety Bond Insurance Company will determine whether the default is an admissible default or not. Once the Surety Bond Insurance Company agrees that the default is admissible, then the Insurance Company will also assess the quantum of loss. So, the maximum value which would be paid would be the Bond Value and depending upon the quantum if the assessed loss is less than the Bond Value, then only that portion would be paid under the Surety Bond.

What are the types of Surety Insurance Bonds in India?

As mentioned earlier, Surety Bond is a legal agreement between three parties - the Principal, Contractor, and the Surety Bond Insurance Company. It guarantees that the Contractor will complete the project as per the terms of the contract, failing which the Surety Bond Insurance Company will compensate the project owner for the losses incurred.

There are 3 different types of Surety Bonds for infrastructure projects in India, each of which serves a specific purpose:

  1. Bid Bonds: Bid bonds are issued to Contractors during the bidding process. Bid Bonds guarantee that the contractor will enter into a contract if their bid is accepted. The bond amount is usually a percentage of the bid amount, and the contractor has to pay a premium to the surety company.
  2. Performance Bonds: Performance bonds are issued after the contract is awarded and guarantee that the contractor will complete the Project as per the Contract Terms. If the contractor fails to meet the obligations, the Surety Bond Insurance Company will compensate the project owner (Principal) for the losses incurred.
  3. Maintenance Bond: In certain projects, the contractor is responsible for project maintenance during the defect period or the maintenance period. If the contractor is unable to maintain the project during the maintenance period, the Maintenance Bond will trigger to provide compensation to the Principal to repair defects in the completed construction project by the Contractor.

What is the process for purchasing Surety Bonds in India?

The process of obtaining surety bonds for infrastructure projects in India involves the following steps:

  1. Contractor submits a bond application to the Surety Bond Insurance Company, along with the required documentation, such as financial statements, project details, and credit score.
  2. The Surety Insurer evaluates the contractor's financial strength, risk profile, and track record before deciding on the bond amount and premium. The Contractor pays the premium for the Surety Bond, which is typically calculated as a % of the Bond Amount.
  3. Once the bond is issued, the Contractor provides it to the Principal as proof of financial security.
  4. In case of default by the Contractor, the project owner (Principal) files a claim with the Surety Bond Insurance Company, which then investigates the claim and compensates the project owner for the losses incurred, up to the bond amount.

What are the Benefits of Surety Bonds?

Surety Bonds offer several advantages for Contractors:

  1. Surety Bonds involve a third party, the Surety Bond Insurance Company, which assumes the risk in case of default by the Contractor. This provides an additional layer of protection to project owners ie the Principal, reducing the risk of financial losses due to delays or cost overruns.
  2. Surety Bond Insurance frees up funds for the Contractor. The Contractor can use those funds to increase revenues by bidding for additional tenders or new contracts.
  3. Surety Bonds could also help the contractor for saving bank limits for other purposes, such as working capital or to fund expansion plans or to reduce debt.
  4. Surety bonds are a more cost-effective option than Bank Guarantees, as the premium charged by the Surety Bond Insurance Company is usually lower than the fees charged by banks for issuing bank guarantees.

Get Best Quotes for Surety Bonds with Qian!

The infrastructure sector in India faces several pain points, including delays, cost overruns, and disputes. Surety Bonds can help address some of these pain points by providing financial security to Principals in case of non-performance of obligations by the Contractor.

The experienced team at Qian Insurance Broking can assist you with best Quotes for Surety Bonds. If you wish to purchase a Surety Bond, you can email us at insurance@qian.co.in or call us on 022-22044989. We would be glad to assist you.

Get Best Quotes for Surety Bonds with Qian!

FAQS

If a surety bond is breached in India, the bond may be called upon to cover the damages or losses incurred by the party that was protected by the bond.

For example, if a contractor fails to perform their obligations under a performance bond or defaults on their payments, the bond may be called upon to compensate the project owner for any losses incurred as a result of the contractor's breach.

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