How sure is surety in Latin America?
It pays to be sophisticated when it comes to surety in the construction industry in Latin America. For anyone familiar with the surety business in LATAM, especially those who have been stung, they will understand.
A surety bond is an ancillary contract to a building contract, whereby the surety guarantees to the beneficiary that the contractor will meet his obligations under the underlying building contract. They are most commonly seen in very high value construction projects, especially in publicly procured infrastructure projects, where the local authority/government would have the benefit of the bond. Historically, it would be common to see a surety bond for around 10% of the value of the works, but more recently we are seeing bonds for up to 50% of the project in Latin America. Many insurers pass over the opportunity to become a surety because the premiums are not attractive enough to justify taking on this level of exposure, they are not skilled enough in construction matters and/or they simply would not be able to access that sort of money in the short window afforded after a bond is triggered.
Most countries in Latin America have their own unique laws and regulations in addition to the terms of the surety bond itself. It is also important to know that in some countries, a failure to pay/pay on time can be a criminal offence. For example, in El Salvador, the window can be as short as 10 days for an on demand bond (i.e. where time runs from the moment the bond call is made). In an “on demand” jurisdiction, such as this, there is no time for, let alone opportunity, to challenge the validity of the justification of the trigger.
For those that venture into this world, and there are good commercial reasons for doing so, they will know that they need to keep on top of the progress of the project they are guaranteeing. A prudent surety will surround himself with an experienced professional team who can foresee issues timeously, is able to monitor progress and seek to rectify concerns by commercial agreement before time expires. Whereas in other regions, bonds are most commonly triggered when the contractor falls insolvent and thus cannot complete the works, in LATAM, this is not the picture we regularly see. Sometimes, we hear threats of a bond call simply as an additional bargaining tool where the contractor and developer are:
- Unable to reach an agreement on changes to be made to the works.
- Hit delays from events of force majeure.
- Are unable to accelerate completion of the project on time and have run out of money.
- Cannot agree on who will pay for the extensions of time.
They therefore look to their cash rich surety (usually outside of LATAM), especially if they are operating in an on demand jurisdiction. However, a skilled surety and its experienced team will act quickly and negotiate an agreed extension to the bond for an additional premium. Where bonds are conditional, the surety may challenge a call for the full amount of the bond where it does not meet the conditions. Time does not run until all conditions have been met. Therefore, it is critical to ensure that the surety team has construction expertise.
Alternatively, a surety can also step into the shoes of the contractor and complete the project. This is rare as most corporate sureties are probably not permitted to undertake construction activities. For those that can sub-contract this to another contractor, it may be a better option to do so when the project is almost complete (rather than paying over the full value of the bond which would constitute a disproportionate sum when compared with the remainder of the works).
Following the Lava Jato scandal, the largest, most skilled contractors in Latin America are often no longer legally permitted to operate in certain countries. Consequently, completing the project on the sureties’ behalf may not be an option due to a lack of choice of local contractors with the same skills and professional capabilities to handle complex infrastructure projects of this nature.
Instead, we are seeing an influx of Asian contractors winning large, publicly procured projects such as the new metro rail in Colombia and Panama. It remains to be seen whether these contractors are prepared to step into the shoes of the local Latin American contractor half way through the works and whether the surety would want to be in that position.
Furthermore, we are commonly seeing a lack of clarity or failure to define the duration the bond following post-handover of the works and whether the full sum of the bond is reduced, commensurate with the stage of the works and post completion.
In summary and to avoid these situations, we would advise addressing these issues when the wording of the bond is being agreed and safeguarding the risk of no collateral warranty at the time of underwriting.