Surety Guarantee â€“ A Growth Enabler

by Pankaj Bhansali, COO, Eqaro Guarantees

A surety is the assurance of the financial or the performance obligation of one party by another. It is a person or an organization that assumes the responsibility of fulfilling the contractual obligation in the event of a default by the obligee. It is a risk transfer mechanism where the surety company assures the obligee/project owner that the principal/contractor will perform his obligation as per the contract A surety is “A cover against contractual defaults resulting in financial loss”.

A surety bond is a contract among three parties:

The Obligee: the party who is the recipient of an obligation
The Principal: the primary party who will perform the contractual obligation
The Surety: who assures the obligee that the principal can perform the task

A Surety is a promise to indemnify the third party from loss arising from the Surety Provider’s client’s default of the contracted terms.

Sureties – A Global Practice

Sureties do not cut across banking lines and consume on productive collateral or margin money. Surety guarantees can also help create a big impact in the economy by infusing liquidity back in to the economy by way of unlocking the money tied up in unproductive cash collateral and security deposits.

Following are the important product lines where surety guarantee can be used extensively

Retail	MSME	Infrastructure
Real Estate	Payment Default Guarantees	Bid-Bonds
Residential Rental Bonds	Dealer Default Guarantees	Performance Bonds
Commercial Rental Bonds	Credit Default Guarantees	Advance Payment Guarantees
Co-Living Rental Bonds	Custom Bonds	Retention Bonds
Property Deposit Bonds	Residual Value Guarantees
Pre-Sale Underwrites	Advance payment Guarantees

Benefits & economic impact for infraand construction industry
The Prime Minister of India recently unveiled ‘PM Gati Shakti Plan’–a Rs 100-lakh crore framework to help build ‘Holistic Infrastructure’ in India. Each of these contracts will require the contractors to put up various guarantees over the life cycle of the project. It may together total up to 15-20% of the overall cost of the project. Currently, most guarantee requirements are catered to by bank guarantees which suck out liquidity from a contractor who is already reeling from a liquidity crisis. More overbanks are now increasingly unwilling to lend to the infrastructure sector as they need to keep a check on their NPAs.
Major challenges to the Indian infrastructure sector’s growth are project delays & cost over runs, pressure on working capital, difficulty in fund raising & high cost of funds. Sureties on the other hand have demonstrated a track record of imposing discipline in project execution by the contractor thus helping address the challenges of the infrastructure industry.

Benefits to Project Owners

A Surety provider undertakes a 360-degree assessment of the company, whereas a bank only undertakes financial underwriting. By doing away with the need for collaterals, Surety Bonds helps increase project opportunities for qualified, efficient & competent contractors who may other wise have been unable to participate due to locked collateral, chocked banking lines and the ensuing liquidity crunch. Higher participation encourages competitive bidding for the projects thus helping reduce the overall cost of the project.

Performance Guarantee or covering financial loss

Bank Guarantee provides cover against a financial loss once it has already occurred – case of contractual failure, delays, whereas Surety providers guarantee performance during the course of the contract and assist through constant project monitoring so that a situation of failure does not occur.

By virtue of their comprehensive underwriting, Surety providers do away with the need for collaterals to indemnify the guarantees issued. As a result, contractors do not have to lock in their working capital to provide margin money or offer collateral, freeing up working capital and collateral to provide much needed liquidity for timely project execution. Surety Guarantees impart efficiency the management of working capital for the contractor.

Current Law and Regulatory Regime for Sureties

IRDA, the insurance regulator recently announced the draft surety insurance guidelines. Based on the draft guidelines the Guarantee business will be governed under IRDAI regulations. The draft guidelines will support the growth of the infrastructure industry in India and spur investments in space. The IRDAI, before coming up with final guidelines, will have to work extensively on clarification of the rights of surety in case of default and ensure the safety of the surety providers.