You’ve secured terms for a performance bond, but why are you now being asked to sign a counter indemnity?
What is an Indemnity?
An indemnity is a promise to pay, a form of security that obligates one party to pay for the losses sustained by another.
To put this into a surety context, if there is a successful claim against a bond issued on a contractor's behalf and the surety pays a claim, they will then seek to recover funds from the indemnitor (the contractor) under the indemnity document, up to the amount claimed under the bond.
Surety is not insurance.
When providing a surety bond, the surety simply lends the strength of their balance sheet to their client (the contractor) in order to guarantee the client's contractual obligations. The surety therefore request an indemnity from the client to support the issue of the surety bond.
Although performance bonds are provided by insurance companies, surety is an industry that does not fall within the realms of traditional insurance. Surety providers do not protect the contractor against losses. Instead, they provide a guarantee to the project owner (employer), to guarantee that the contractor will fulfil its obligations under a contract. So, it is important to appreciate that a performance bond is not an insurance policy, but a guarantee.
Net zero.
Surety underwriters, unlike general insurers, aim to write their business on a zero loss ratio basis. The underwriters will undertake a substantial review of every client and will critically evaluate the probability of default. Whilst regulators demand that traditional insurance products carry a loss ratio of 30% to 40%, surety has no minimum loss ratio from the regulator, if the surety provider deems the risk level too high, they will decline to quote.
In order to protect themselves against the risk of a successful claim on a bond, surety providers require an indemnity to give them the legal recourse to recover their losses in the event that the client remains solvent or has other trading entities within the group.
If the client is contractually obliged to reimburse the surety in a claim scenario, what is the point of a surety bond?
To answer this question, the alternatives must be considered. The primary alternatives to a performance bond are:
(a) Parent Company Guarantees "PCG"
(b) Bank-Backed Guarantees
(c) Increased project retention or cash collateral placed on deposit directly with the employer.
Whilst the above are valid forms of financial protection for the employer, it is worth noting that all provide an arguably worse outcome for both the contractor and the employer.
The strength of a PCG is limited to the strength of the parent company whereas a bond sourced via Phillips Schroeder Surety will only be obtained from rated and regulated insurance companies with credit rating worthy balance sheets and comprehensive reinsurance structures. Therefore a surety bond usually provides a greater level of protection for the employer.
Banks are typically willing to provide bonds on an on-demand basis and take security in the form of a debenture (a charge). Banks will often pay the full bond amount upon first demand (without damages being established and ascertained) and rely upon its debenture to recoup the funds advanced in satisfaction of a claim. The contractor therefore loses any control in the claims process.
With an increased cash retention held on deposit, no bond is in place and the employer has unencumbered access to funds and the contractor therefore has less control over the claims process. Furthermore, the contractor might expect the employer to seek discounts during negotiations to release the enlarged retention.
Necessary evil?
By contrast, the protection afforded by surety providers puts the contractor in a commercially superior position. Damages following a claim must be established and ascertained before the surety will make payment. A surety provider therefore will work with the contractor, to limit damages to what is fair and actual. In an insolvency scenario, a surety provider would rank as an unsecured creditor after calling in the indemnity. It is the best interests of the surety provider to limit what is paid under any claim as the prospect that a surety can recoup any monies paid out to satisfy a claim is relative to their status as an unsecured creditor. Which is also why they will look to work with the contractor if a claim is made whilst the contractor is solvent and a going concern.
Indemnities can appear onerous.
PSS act as surety agent, and as such we are not able to give legal advice and we encourage our clients to seek independent legal advice before signing an indemnity document.
Surety is a niche industry and confusion often surrounds indemnities so there is value in discussing the indemnity with a legal firm that specialises in surety.
The indemnity documents are onerous in nature, but the surety providers are giving critical support as an otherwise unsecured third party and allow contractors to win business and grow. Indemnities follow the underlying bond or bonds issued under the facility to which they support.
If the bonds issued on the contractor's behalf remain fully conditional and a claim is dependent upon a breach of the underlying contract with the damages payable being fully established and ascertained, the indemnity is less likely to be called. If the surety has issued on demand bonds on the client's behalf then the bond is more liquid and therefore the indemnity is also more likely to be called. The surety does reserve the right to call cash cover against all bonded liabilities, the circumstances in which they can call cash should be fully understood by all indemnitors.
Are all indemnities the same?
No. There is no uniform indemnity document. Each surety provider has its own indemnity document, so terms and conditions can differ between providers. Indemnity documents continues to evolve as the litigious nature of society and the legal framework become more complex.
Your surety broker will be able to provide sample indemnity texts from each surety provider, the cheapest terms aren't always the best option and contractors should compare the security documentation alongside the other terms.
I have more questions and I don't want to complete an online form.
Please feel free to call or email one of our experts. Henry Baird on 07901043444, Henry Robbins on 07944883053 or Rick Phillips on 07903365653 or email henry.baird@pssurety.co.uk or henry.robbins@pssurety.co.uk or rick.phillips@pssurety.co.uk
Comments