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What Is Surety Bond?

What Is Surety Bond?

The Ministry for Road Transport & Highways (MORTH) has asked insurance regulator Insurance Regulatory and Development authority (IRDAI) to develop a model product on Surety Bonds in consultation with general insurers.

  • Several challenging issues which made Surety Bond a complete non-starter with the insurers have also been discussed and it was proposed to IRDAI that it should design a model product.
  • The issue of Changes to the Indian Contract Act as well as the Insolvency and Bankruptcy Code (IBC) was also highlighted so that Surety Bonds are on the same footing as bank guarantees when it comes to recourse available to them in the case of default – are also being considered.
  • A surety bond can be defined in its simplest form as a written agreement to guarantee compliance, payment, or performance of an act.
  • Surety is a unique type of insurance because it involves a three-party agreement. The three parties in a surety agreement are:
    • Principal – the party that purchases the bond and undertakes an obligation to perform an act as promised.
      Surety – the insurance company or surety company that guarantees the obligation will be performed.
    • If the principal fails to perform the act as promised, the surety is contractually liable for losses sustained.
    • Obligee – the party who requires, and often receives the benefit of— the surety bond. For most surety bonds, the obligee is a local, state or federal government organization.
    • Surety bond is provided by the insurance company on behalf of the contractor to the entity which is awarding the project.
  • Aim:
    • Surety bonds are mainly aimed at infrastructure development, mainly to reduce indirect cost for suppliers and work-contractors thereby diversifying their options and acting as a substitute for bank guarantee.
  • Benefits:
    • Surety bonds protect the beneficiary against acts or events that impair the underlying obligations of the principal.
    • They guarantee the performance of a variety of obligations, from construction or service contracts to licensing and commercial undertakings.

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