Surety bond as an instrument to boost national infrastructure
1. Brief product introduction
The need to develop infrastructure sector in Brazil, combined with the technical and legal complexity of the related projects, ends up requiring from the engaged parties a detailed study of the risks involved in its various phases.
Efficient management tools are necessary to develop this study, and we can say that the greater or lesser success of a given project is directly linked to the capacity of those engaged to identify and measure the risks of the operation and to correctly allocate them among the various players involved in it.
The mitigation of these risks, especially those related to a default scenario, can occur not only through contractual and management mechanisms, but also through an insurance package structured in accordance with the technical and legal specificities of the project to which it is intended.
In this context, surety bond is presented as an important instrument for the insurance sector, which aims, according to the chosen modality, to guarantee the compliance with the obligations assumed through the contracts formalized in several insurance lines, including infrastructure works and projects, provision of services, supply of goods, and many others.
Surety bond is a damage insurance, given its clear objective of compensation (Arts. 7571, 7782, 7793 and 7814 of the Brazilian Civil Code).
“It is a modality that aims to guarantee to the insured the payment of compensation in the event of damage or loss to a thing or an asset, within the limits of the contract5“.
It originated in the United States, aiming at promoting and providing more guarantees for the development of infrastructure projects.
Over there, where it has been operating for more than one hundred and twenty (120) years, this product is consolidated and plays an important role in delivering relevant works to the development and growth of the country.
And this happens primarily due to the regular exercise of the so-called step in rights, which allows the guarantor, which is the insurance company in this case, to intervene directly in the project, in addition to the fact that there are no surprises when recovering the amount compensated by the insurance company, directly from the Principal, since the subrogation operates in full right from any payment (general insurance conditions, counter-guarantee contract and Arts. 346, item III6, 3497 and 7868 of the CC).
In Brazil, where this product has been commercialized for almost fifty (50) years, the market is still looking for ways to make it more attractive and efficient, especially to the public sector.
In spite of this, there is no doubt that it is a good solution for the improvement of economic indices and for the growth of the country.
2. Current regulation
In Brazil, surety bond is regulated by the Superintendence of Private Insurance – SUSEP, largely by SUSEP Circular 477, of September 30th, 20139, which expressly revoked SUSEP Circular 232, of June 3rd, 2003, which was regulating this product until then.
SUSEP Circular 577, of September 26th, 201810, introduced some changes to the mentioned rule, which we will deal later, in a brief summary.
Circular 477/2013 introduced several changes in surety bond, especially to adapt the regulation in force to the new reality of the insurance operations, especially in the scope of construction, supply and provision of services in general.
This Circular, broadly speaking, divides surety bond into two main lines:
(I) Insured – Public Sector (Line 0775) and
(II) Insured – Private Sector (Line 0776).
Specifically on the Public Sector, according to Art. 4th of the Circular, this insurance aims to guarantee the faithful compliance with the obligations assumed by the principal with the insured due to participation in bidding, in the main contract relating to works, services, including advertising, purchases, concessions or permissions within the scope of the Powers of the Union, States, the Federal District and the Municipalities, or even the obligations assumed due to:
I – administrative proceedings;
II – lawsuits, including tax enforcement;
III – administrative installments of tax credits, registered or not in active debt;
IV – administrative regulations.
The amounts owed to the insured are also guaranteed by this insurance, such as fines and compensation, arising from the default of the obligations assumed by the principal, provided for in specific legislation, for each case.
Specifically for Surety Bond: Insured – Public Sector (Art. 6th, §1st) the following are defined:
I – Main Contract: any and all adjustments between bodies or entities of the Public Administration (insured) and private individuals (principals), in which there is an agreement of wills for the formation of connections and the stipulation of reciprocal obligations, whatever the denomination used.
II – Insured: the Public Administration or the Granting Power.
On the other hand, Art. 5th of the Circular defines Surety Bond: Insured – Private Sector, as being the insurance that aims to guarantee the faithful compliance with the obligations assumed by the principal with the insured in the main contract concluded in a scope other than that mentioned in Art. 4th.
Specifically for this line, according to Art. 6th, §2nd, the following are defined:
I – Main Contract: the contractual document, its amendments and attachments, which specify the obligations and rights of the insured and the principal.
II – Insured: creditor of the obligations assumed by the principal in the main contract.
The principal, for both lines, is the debtor of the obligations assumed by him with the insured, and the claim is characterized by the absolute default by the principal relating to the obligations covered by the insurance.
Also according to the Circular, the insurance company will compensate the insured, by agreement between the parties, or by carrying out the object of the main contract, through third parties, in order to give continuity, under its full responsibility; and/or by compensating, by means of cash payment, losses and/or fines caused by the default of the principal, covered by the policy (Art. 13).
In its attachments, Circular 477/2013 brought the terms of the standard surety bond clauses in both lines, making possible for insurance companies to submit specific changes and propose the inclusion of new modalities and/or additional coverage.
Prior to commercialization, such changes must be submitted to Susep, which may accept them, refuse them or even partially accept them.
The inclusion of particular clauses is also allowed in order to discipline specific situations of each operation, as long as they do not conflict with the current rules that regulate the product.
According to Susep, insurance companies will be able to submit their own products through non-standard plans, respecting the current rules and the provisions of Circular 477/2013.
Non-standard plans that contain any modalities and/or additional coverage must fully follow the wording contained in the attachments of Circular 477/2013 and, equally, must be submitted to the assessment of the municipality prior to commercialization.
The issuance of a surety bond policy is normally linked to the formalization of the so-called counter-guarantee contract between the insurance company and the principal, and regulates which guarantees are offered by the principal for the purpose of underwriting that particular risk and which will enable the reimbursement of the amounts that will eventually be compensated by the insurance company due to the occurrence of the risk covered by the policy.
In this regard, Circular 477/2013 maintained the provisions on the counter-guarantee contract that governs the relationship between the insurance company and the principal for the purpose of reimbursement. According to the regulations, the counter-guarantee contract remains a free pact between the parties and without any interference by the insured, and does not need to be submitted to prior assessment of the autarchy.
3. The various modalities of surety bond
The extensive network of contracts in their various modalities represents a specific risk according to the type of obligation to be accomplished, which may be construction, supply, service provision, perfect functioning, corrective maintenance, and many others.
Therefore, insurance must be contracted according to the risk involved in each phase of the project, and some specific modalities provide coverage that are more used and destined to the infrastructure sector.
In this regard, Circular 477/2013 provides, in its attachments, various modalities of surety bond for the public and private sectors. They are basically:
(i) bidder surety bond (public sector);
(ii) surety bond for construction, supply or provision of services (public and private sector);
(iii) surety bond for payment retentions (public and private sector);
(iv) advance payment surety bond (public and private sector);
(v) surety bond for corrective maintenance (public and private sector);
(vi) judicial surety bond (public and private sector);
(vii) judicial surety bond for tax enforcement (public sector);
(viii) surety bond for fiscal administrative installments (public sector);
(ix) customs surety bond (public sector);
(x) administrative surety bond for tax credits (public sector); and
(xi) real estate surety bond (private sector).
In addition to these modalities, Circular 477/2013 also provides for the possibility of additional coverage for labor and social security lawsuits.
The purpose of this coverage is to guarantee, exclusively to the insured, the reimbursement of the losses proven to be incurred, in relation to labor and social security obligations of the principal arising from the main contract, claimed in court, in which there is a judicial conviction of the principal to the payment and the insured is subsidiarily convicted.
It aims to protect the insured, therefore, from the losses caused by non-compliance of the principal with respect to the payment of labor sums due to the employees seconded to act within the scope of the main contract, guaranteed by the insurance, always, of course, respecting the maximum compensation limits provided for in the policy.
Circular 477/2013, as seen above, was amended by Circular 577/2018 which included, among its clauses, Chapter IV (Particular Conditions of Specific Clauses – Line 0775 – Public Sector), which deals with the Specific Clause called “Labor and Social Security Lawsuits”.
Said Circular 577 determines that the public sector surety bond policies, which guarantee contracts involving the provision of services with a regime of exclusive dedication of labor, mandatorily provide coverage for losses suffered by the insured due to non-compliance with the obligations of labor and social security nature of the responsibility of the principal, arising from the main contract, but regardless of the existence of a lawsuit and of the subsidiary liability of the insured is recognized, as in case of additional coverage for labor and social security lawsuits.
For other modalities of contract, said clause may be contracted as additional coverage, provided that there is a specific legal provision for such purpose.
Said Circular, in turn, does not change Chapter III of Circular 477/2013 – Special Conditions for Additional Coverages – Line 0775, Additional Coverage I: Labor and Social Security Lawsuits, and the conditions for the additional coverage mentioned above remain unchanged.
In addition, Susep proceeded to adjust the wording of three standardized clauses contained in Circular 477/2013, namely, those contained in (a) item 7.3, of Chapter I, of Attachment I, of the Circular, (b) item 14.2, of Chapter I, of Attachment I, of the Circular, and (c) item 7.4, of Chapter II, of the Circular.
Once provided these brief clarifications relating the insurance modalities, we shall highlight below, for the purposes of this paper, those that can best contribute to the development of the infrastructure sector in Brazil.
4.1. Surety bond for construction, supply or provision of services (performance guarantee or performance bond)
The surety bond for construction, supply or provision of services, also known as performance guarantee or performance bond, aims to guarantee compensation, up to the amount of the guarantee set in the policy, for losses resulting from the default of the obligations assumed by the principal in the contract for construction, supply or provision of services.
Compensable loss, in turn, refers to the pecuniary loss proven by the insured, in excess of the original amounts foreseen for the execution of the main object of the contract, caused by the default of the principal, excluding any loss arising from another insurance line, such as civil liability, loss of profits, and others. It is, therefore, a legitimate case of extra cost.
For the public sector, the amounts of fines and compensation due to the Public Administration are also guaranteed, in view of the provisions of Law 8,666 of June 21st, 1993 (“Public Bidding Law”).
4.2. Payment retentions surety bond
The payment retentions surety bond is intended to guarantee the compensation, up to the amount of the guarantee fixed in the policy, of the losses caused by the principal to the insured, due to default of the obligations linked to the payment retentions provided for in the main contract and replaced by the policy.
Therefore, this insurance replaces the retention of payments on each invoice, that are normally required by the contractors, so that a certain amount is kept in deposit for the payment of any repairs or corrections.
Especially in construction, it is normal for the contractor to require a retention on each invoice. Without the surety bond, the retentions themselves would end up charging the price of the work, as the contracted parties may be required to finance the retained portion.
In general, the cost of insurance is much lower than the cost of financing the retained part, proving it as a good alternative from a financial point of view.
4.3. Advance payment surety bond
The advance payment surety bond aims to guarantee the compensation, up to the amount of the guarantee established in the policy, for the losses resulting from the default of the obligations assumed by the principal in relation exclusively to the payment advances granted by the insured, which have not been settled as provided for in the main contract and duly expressed in the object of the policy, regardless of its conclusion.
In this modality, the contractors who eventually advance amounts to the contracted party, without the immediate counterpart in the form of the services for which the advances are intended, usually condition such payments to obtaining the surety bond, in general for the total amount of the advance.
In case of non-amortization of the advance as provided for in the contract, the surety bond is activated, which may compensate the insured for the difference that is not offset through the adjusted services. If the amortization occurs normally, the guarantee is released.
4.4. Corrective maintenance surety bond
The purpose of the corrective maintenance surety bond is to guarantee the compensation, up to the guarantee amount provided for in the policy and during its validity, for the losses resulting from the failure, within the agreed term, of the corrective actions pointed out by the insured to the principal and necessary for the correction of the dysfunction that occurred under the sole responsibility of the principal.
Therefore, it is an additional comfort to the contractor, in the sense that, after delivery of the contractual scope, he may have the necessary corrections due to a certain malfunction.
4.5. Real estate surety bond
The real estate surety bond has the purpose of guaranteeing the compensation, up to the guarantee amount established in the policy, for the losses resulting from the default of the principal in relation to the obligations assumed in the purchase and sale contract relating to the construction of buildings or set of buildings of autonomous units sold during the execution of the work or in the exchange agreement.
The coverage of this policy guarantees the reimbursement of losses caused by the increase in the cost of construction of the projected work, whether fixed or readjustable, in case of a contract regime, or integral, in case of management regime, up to the insured amount contracted.
For the purposes of this modality, insured is defined as those who acquire property under construction of multifamily or commercial units, including “shopping centers” or the owners exchanging lands or ideal fractions of land(s), organized in condominium, and principal as the real estate developer or the construction company.
4.6. Performance bond for civil construction
In the scope of civil construction, the obligation covered by the surety bond provided by the insurance company is that established in the contract concluded between the insured (contractor) and the principal (contracted party), in its various modalities, and can be used both in the main contract (signed between the developer and the builder, for example) as in the various subcontracts signed by the main constructor.
Based on the concept of performance, we can say that surety bond has as its central risk the non-compliance of a certain contractual obligation by the principal in the due time and manner, which, in civil construction works, for example, has its origin linked to a deviation from the schedule, which, if unsolved, leads to an absolute default of the obligation and consequently to the claim.
As a rule, the insured amount corresponds to between five (5) and fifteen percent (15%) of the total amount of the contract, which means that, depending on the moment of the work in which the claim occurs, the insurance may not be sufficient for its resumption and conclusion, being necessary the adoption of other measures to resume the physical and financial flow of the object of the contract.
In this case, we can say that the surety bond will act as an element to stimulate the resumption of works, but it will not always solve the problem as a whole.
In practice, many deviations from the schedule originate from management failures that end up generating financial deficits and the infeasibility of continuing the project along the lines originally planned.
Good management must involve both parties, contractor and contracted party, so that performance deviations are overcome in their initial phase, avoiding the so-called cascade effect represented by a series of sequential defaults.
As stated above, compensable loss refers to the pecuniary loss proven by the insured, exceeding the original amounts provided for the execution of the object of the main contract, caused by the default of the principal. It is usually configured with the contracting of third parties for amounts higher than the original contract, for the execution of the remaining scope of the responsibility of the principal.
5. Insurance coverage limits
The very broad object, as defined in surety bond policies, as well as the various causes that can lead to a performance problem, usually generates confusion relating the scope of this type of insurance.
The definition of the object, in its general conditions, can often contribute to the mistaken understanding that the insurance coverage applies to any and all non-compliance with the contract, when, in fact, the coverage is limited by the contracted modality and by the provisions contained in the policy.
Surety bond, in the advance payment modality, for example, is linked to the amount of the advance granted by the contractor to the contracted party and aims to reimburse the insured for the part that may not have been offset, as planned, during the execution of the contract.
In the construction executing modality, it is linked to the main construction obligation and, therefore, in the event of default of this obligation, the coverage will be applied to recompose the construction deficit resulting from the default of the principal, according to the originally contracted obligation.
This means that there will be no coverage for contractual defaults that are not linked to the constructive obligation or that result from changes in the scope originally contracted, since the risk subscribed and accepted by the insurance company is related to the risk factors present at the time of contracting.
Losses covered are those linked to the contracted modality and are not referred to any and all losses; it is essential that the insured demonstrates the losses suffered, which is a basic rule in damage insurance. The compensation received by the insured must restore him to the status quo ante, what means that it is not intended to provide the insured with a better situation than he had before the claim, reflecting the compensation principle provided for in the Brazilian Civil Code, as cited above.
In addition to the limit dictated by the modality of surety bond, the policy, in its special and particular conditions, must expressly inform the covered and excluded risks.
6. Claim and the hypotheses of absence of contractual coverage
In general, the surety bond claim is characterized by an absolute default of the obligation subject to the guarantee, an absolute default being understood as the impossibility or useless fulfillment of the obligation by the principal, normally followed by the contractual termination that does not allow the full execution of the contractual scope.
It is distinguished, therefore, from a simple default, which may give rise to an expectation of loss, but in which there is still the possibility of compliance by the principal, even with a delay and with the application of contractual penalties provided for in the main contract.
Once the absolute default has been verified and the claim is notified by the insured, the insurance company must initiate the loss adjustment proceeding, to investigate the causes, responsibilities, amounts and losses that may be compensated according to the modality in question.
During the loss adjustment proceeding, any causes of loss of right to compensation, as defined in the general conditions of the policy for both public and private sectors, must also be investigated; we here transcribe the standard text:
Loss of rights: The insured will loose the right to compensation in the event of one or more of the following hypotheses:
I – Fortuitous or force majeure cases, under the terms of the Brazilian Civil Code;
II – Non-compliance with the obligations of the principal arising from acts and facts of the responsibility of the insured;
III – Change of the contractual obligations guaranteed by this policy, which have been agreed between the insured and the principal, without the prior consent of the insurance company;
IV – Malicious unlawful acts or for serious fault comparable to the deceit practiced by the insured, the beneficiary or the representative, of one or the other;
V – The insured does not fully comply with any obligations provided for in the insurance contract;
VI – If the insured or his legal representative makes inaccurate statements or omits in bad faith circumstances of his knowledge that constitute an aggravation of the risk of default of the principal or that may influence the acceptance of the proposal;
VII – If the insured intentionally increases the risk.
The above hypotheses are based, especially, on the fact that the covered default is the default of the principal, and not the default of the insured; that is, the actions or omissions of the insured are not covered by the surety bond, which, as seen, is lended to cover the breach of contract by the principal in accordance with the limits of the contracted modality.
Accordingly, if the default of the principal and the consequent contractual termination have been caused or contributed by the insured, he shall loose the right to compensation, under the terms of the above regulatory provisions.
Another very common situation in infrastructure projects that can lead to the loss of the right to compensation is the change in contractual obligations without the prior consent of the insurance company.
This normally occurs through project changes, increased services and quantities, scope extensions, failure to pay amounts in the manner and term provided for in the contract, and others, which clearly impact the adjusted physical-financial schedule and, consequently, change the risk underwritten by the insurance company.
In this sense, a fundamental measure to maintain the effectiveness of the insurance contracted is previously inform to the insurance company all changes introduced in the obligations of the main contract, so that it can assess and, if applicable, issue the competent endorsement of the policy to cover the new element added to the risk originally assessed.
As discussed throughout the present work, surety bond appears to be an important instrument for the development of the infrastructure sector of Brazil, constituting a good alternative of contractual guarantee, as it relieves the assets of the contracted party that would be unavailable in the so-called conventional guarantees; it constitutes, still, a relevant instrument to promote the continuity of a project when that same contractor stops performing its obligations.
For its full effectiveness, however, it is important to correctly understand the product, in its various modalities and in the scope of its respective coverage, and it must be clear that surety bond will not always be able to remedy all the consequences of the default of the principal.
Policy management will contribute to the proper functioning of the insurance, in terms of validity, coverage and good communication with the insurance company, for the purpose of keeping it informed about relevant facts that may impact the risk subject to the guarantee and even as a way to count on its expertise to avoid a claim, also minimizing the risk of occurrences that may lead to the loss of the right to compensation.
Another aspect to be highlighted is the importance of good contractual management, which should provide for the rapid identification and overcoming of deviations from the physical-financial schedule, therefore mitigating the risk of the occurrence of serial defaults, involving other stages and participants of the project.
And such is the importance of this product, some years ago, in Brazil, all the players of the market started negotiations to present the surety bond as a more effective solution for the development of infrastructure in the Country.
As a starting point, the insurance market, represented by three federations, namely, the National Federation of Private Insurance and Reinsurance, Capitalization, Private Pension, Insurance and Reinsurance Brokers – Fenacor, the National Federation of Reinsurance Companies – Fenaber, and the National Federation of General Insurance – FenSeg, have been talking with representatives of the legislative, executive and regulatory agencies, in addition to some financial institutions.
As a result, countless bills of law have been passed in the Chamber of Deputies and in the Federal Senate since then, providing for increases in the guaranteed amount, as well as various responsibilities to the insurance companies operating the product, which will have a relevant role even in preventing corruption within the scope of contracts mainly signed in the public sector.
Some of these legislative proposals, for example, foresaw increasing the percentage of the insured amount to up to one hundred percent (100%) of the amount of the guaranteed contract, and also the obligation of the companies to supervise, audit and conclude the paralyzed works, even assuming the liabilities of the principal.
Such proposals, however, have been assessed with great caution, since many of them aim to transfer the responsibility of the State to the insurance market, which can bring negative economic impacts to the sector, mainly due to the exposure of companies to various risks that are not contemplated by the policies, but which are inherent to guaranteed operations, such as those arising from defaults on labor, social security, non-compliance with tax, environmental and other obligations.
In any case, surety bond is still a major bet for the insurance sector for the coming years, and is expected to grow with the approval of Bill of Law No. 1,292/95, known as the New Bids and Contracts in Public Administration Bill of Law.
Said bill proposes, among others, an increase from five percent (5%) to fifteen percent (15%), to thirty percent (30%) of the guarantee amount for contracts exceeding BRL $ 100 million reais, in addition to the introduction of the clause for resuming the conclusion of the object contracted by the insurance company.
Market, however, is looking for some changes so that the operation of the product along the lines suggested becomes viable, primarily related to (i) the easing of forecasts that impose on insurance companies the duty to supervise and audit contractual execution; (ii) the suppression of sections that provide that the insurer pays the employees of the principal directly in the event of a claim, provided, of course, that there is coverage for such purpose; and (iii) the reduction of fines fixed in case the insurance company chooses not to conclude the scope of the defaulted contract, if the contractor does not do so.
In addition, insurance companies are seeking to meet some specificities provided for in the financing contracts proposed by development banks, but it is known that the market is unable to assume all the risks of the business of these institutions.
Market, in general, is optimistic about this product, which in fact should remain an important instrument in the development of national infrastructure.
But from the implementation of the proposals in process, it will be of paramount importance that insurance companies improve their underwriting, assessment and risk monitoring processes, which can/should even be done by a multidisciplinary team, all as a way of guarantee financial health to the portfolio and the effectiveness of the operation.
The challenges are not few, but it is certainly an important tool able to boost the growth of the Country.
1 Art. 757. Under the insurance contract, the insurer undertakes, upon payment of the premium, to guarantee the legitimate interest of the insured, relating to a person or thing, against predetermined risks.
2 Art. 778. In damage insurance, the promised guarantee cannot exceed the value of the insured interest at the time of the conclusion of the contract, under penalty of the provisions of art. 766, and without prejudice to the criminal action that may be applicable.
3 Art. 779. The insurance risk will include all the resulting or consequent losses, such as the damage caused to avoid the claim, to reduce the damage, or to save the thing.
4 Art. 781. The compensation cannot exceed the value of the insured interest at the time of the claim, and, under no circumstances, the maximum limit of the guarantee fixed in the policy, except in case of default by the insurer.
5 Nelson Rosenvald and Felipe Braga Netto, in Civil Code Commented article by article, Ed. JusPodivm, 2020, p. 782.
6 Art. 346. Subrogation operates, in its own right, in favor of:
III – the interested third party, who pays the debt for which he was or could be obliged, in whole or in part.
7 Art. 349. The subrogation transfers to the new creditor all the rights of the primitive, his actions, privileges and guarantees, in relation to the debt, against the principal debtor and the guarantors.
8 Art. 786. When the compensation is paid, the insurer subrogates, within the limits of the respective amount, in the rights and actions that belong to the insured against the author of the damage.
Authors: Débora Schalch, Tatiana Algodoal Rosa, Juliana Zukauskas
Schalch Sociedade de Advogados – SSA
Avenida Faria Lima, 4509, Itaim Bibi
Postal Code: 04538-133 – São Paulo, State of São Paulo.
Phone: (11) 3889-8996
E-mail: [email protected]