Clarity on rights needed, recourse available to surety insurance companies


IRDA, the insurance regulator, announced the draft surety insurance guidelines in September 2021. Once finalized, the standards will guide surety business in India.

What is the deposit? How it works?

To get started, let’s understand what a surety is and how it works. A person / company giving the security is called the surety, while the person in respect of whom the security is given is called the principal debtor or the debtor, and the person to whom the security is given is called the creditor or the creditor . The liability of the surety is generally coextensive with that of the principal debtor.

The basis for underwriting surety is the zero loss assumption – meaning that the underwriter approaches the proposal with the belief that the underlying obligation will certainly be fulfilled.

As such, it is imperative that the surety be assured of a full recourse against the principal in the event of default and subsequent appeal to the guarantee.

What are the regulations in force?

Let us examine the provisions of the regulations currently in force with regard to the rights of recourse available to the surety. According to section 140 of the Indian Contract Act, the surety takes the place of the obligee after the surety has paid the secured debt or performed what he was responsible for. Therefore, the surety is entitled to all remedies that the obligee had against the obligor, including the property of the obligor. This surety’s right of intervention is also called the right of subrogation.

Rights of the financial creditor, operational creditor

The IBC grants the surety certain rights under the Act, which includes the right of a surety to initiate corporate insolvency proceedings against the debtor. The IBC also distinguishes between a financial creditor and an operational creditor and the rights they have under the IBC.

Additionally, since the surety substitutes for the original creditor under the Indian Contract Act, it is important to determine the exact nature of the debt in order to understand the rights of a surety under the IBC.

A financial creditor includes any person to whom a financial debt is owed, while an operational creditor refers to a person to whom an operational debt is owed. These two debts include any person or entity to whom these debts have been legally assigned or transferred.

In addition, it is important that a debt has been disbursed for a consideration of the time value of money to be classified as a financial debt. Operating debt would mean other debts which include debt for the provision of goods or services, including employment and contributions due due to the application of a law and payable to the central government or state government or other authority.

The IBC grants differentiated rights depending on whether a creditor is an operational or a financial creditor. Operational creditors are neither included in the creditors committee, nor can they vote on any resolution during the insolvency process and are ranked lower in the hierarchy below financial creditors for the distribution cascade.

No clarity on the surety’s status as a creditor

This is where it becomes a bit of a concern for a future surety insurance company. If we consider the example of a contractor carrying out a road project for NHAI and who would fail to meet his obligations leading to the invocation of the guarantee, there is no clarity on the status of the surety as a creditor. . In accordance with the Indian Contract Act, a surety will replace the NHAI.

Since there is no time value of the money exchanged for consideration, a surety is certainly not a financial creditor, while at the same time, NHAI has not provided the contractor with any goods or returned no service to the contractor for which money is owed. This is simply a case of non-compliance with the contractual conditions for which the warranty was invoked and which does not take precedence under the IBC.

It becomes more of a concern – the surety’s right of subrogation is based on the simple principles of fairness and justice which form the basis of surety taking. However, there have been many cases in India that have been resolved under the IBC in which the rights of subrogation have been denied to the guarantor.

If the concept of surety insurance is to flourish in India and achieve the desired goal of building surety capacity in our country, thereby providing much needed relief to the contracting community, care should be taken to clarify the rights and remedies available. for the deposit. insurance companies. Surety companies need to be sure that they know how and where they stack up against other regulations in India.

(Vikash Khandelwal is CEO, Eqaro Guarantees)

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Posted on: Thursday December 30th, 2021 1:29 PM IST


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