The Ministry of Corporate Affairs is contemplating making amendments to the Insolvency and Bankruptcy Code, 2016 (“Code”) to consider surety bond insurers as financial creditors. This comes at a time when there is a push to promote surety bonds as a product class with the recent introduction of Insurance Regulatory and Development Authority of India(IRDAI) (Surety Insurance Contracts) Guidelines, 2022.
Surety bonds, issued by general insurance companies, ensure the fulfillment of obligations by a business owner (the principal) to a third party (the obligee). The Ministry of Corporate Affairs is addressing concerns raised by insurers who seek similar recovery rights as banks. Pending examination, changes to grant financial creditor status to insurers under the IBC may be implemented.
“One of the potential changes required in IBC would be opening up the pre-packs process for large companies. Currently only MSMEs can avail pre-pack options under the IBC. Considering that the pre-pack envisages debtor in control model (with checks and balances), allowing large companies to resort to pre-pack will likely re-energise the insolvency market since bona fide promoters will have a fair chance to restructure their debt obligations without losing complete control of their company,” said Siddharth Srivastava, Partner, Khaitan & Co.
Surety Bonds: Benefits & Risks
Surety bonds are akin to bank guarantees in their function, however owing to lack of specific clarity in the current IBC framework are not finding their place at par with the Bank guarantee. In the absence of such a clarification, these surety bonds may be viewed by some as operational debt even though they are functionally more aligned to a ‘bank guarantee’, i.e. it provides a standing to ensure the performance of a contract.
“A recognition as a financial creditor would entitle the issuer of surety bond with plethora of rights which inter alia would include right to participate in the resolution process, attend creditors’ meeting and also have a say in the distribution of assets. Although in terms of their priority as a class of financial creditor it will be interesting to see whether they are treated as secured or unsecured financial creditor,” says Ravi Bhasin, Senior Partner, AZB Partners.
The amendment can be made either similar to that of allottees of a real estate project (by adding an explanation) or more suitably can also be by way of inclusion of surety bonds in definition of financial debt (along with guarantees and indemnities).Ravi Bhasin, Senior Partner, AZB Partners.
Bhasin clarifies that while in effect the risk of not getting full or any recovery is being passed on from an operational creditor to an insurer, the insurer will by way of the proposed amendment/ clarification benefit from being treated as a financial creditor.Surety bonds would give the beneficiary a way out by claiming the bond from the insurer (therefore securing them even in case of an insolvency event) and giving them a status even better than a financial creditor (in terms of full recovery).
Reports claim that insurance companies issuing a surety bond in infra financing transactions could be recognised as financial creditors under IBC. “If this becomes a reality, it would be a big move and will also give a massive boost to the surety bond market. Such a move may also result in further increase in debt funding in large infrastructure projects,” says Khaitan.
Experts feel that it would be interesting to see how insurance companies will fill in the shoes of banks in the Committee of Creditors (CoC) and how best they negotiate the resolution plan in the CoC which protects the interests of all the stakeholders involved.
It is noteworthy to recall that, post the budget speech of the Finance Minister Nirmala Sitharaman, the surety bonds are now very well accepted for government procurement which is a substitute for Bank Guarantee. “Another advantage of surety bond insurance is that the collateral required for the same is comparatively lower than the bank guarantee and therefore it is vital to acknowledge the said class of Creditors under the IBC regime. At the same time the issue of conflicting interest between the financial creditors and Insurers may have to be addressed appropriately owing to the fact that both the class of the Creditors might have separate goals for the resolution process,” says Amir Bavani, lawyer & founder, AB Legal, Hyderabad.
