By Pankaj Bhansali
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 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
Sureties – A Global Practice
Sureties do not cut across banking lines and consume productive collateral or margin money. Surety guarantees can also help create a big impact in the economy by infusing liquidity back into 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.
Impact for infra, construction industry, and large economy
The recently announced ‘PM Gati Shakti Plan’ – a Rs 100 lakh crore framework to help build ‘Holistic Infrastructure’ in India. These contracts will require 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 that suck out liquidity from a contractor. Given the impact of the infra and construction sector on the economy, it is bound to boost the growth rate. Infra sector is a huge employment generator that is capable of addressing the current high unemployment rate in the country.
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 otherwise have been unable to participate due to locked collateral, chocked banking lines, and the ensuing liquidity crunch.
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.
Current Laws for Sureties
IRDA has recently announced the draft surety insurance guidelines. The Surety 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.
(Pankaj Bhansali is the COO, Eqaro Guarantees. Views expressed are the author’s own.)