Surety, Bonds and Guarantees 101: Assurance that contractual obligations will be met
In today’s complex business landscape, ensuring trust and reliability is paramount. Whether a company is engaging in construction, mining, logistics, hospitality, institutions of higher learning, property developers, fuel, power or energy providing services or entering large contracts, the assurance that contractual obligations will be met is critical.
According to Sizakele Mbatha, surety manager at Aon South Africa, this is where surety/guarantees/ bonds come into play, offering a robust mechanism to safeguard interests and uphold commitments. “Surety, at its core, involves a promise by a contractor to assume responsibility as contractually agreed. A surety/bond is a tripartite agreement that binds together the principal (contractor) and the obligee (the project owner) with the guarantor (insurer and/or bank), providing a guarantee that the principal will execute and complete the project timeously as agreed and according to contract specifications.”
The importance of bonds for business
At its most basic level, it’s about building trust, enhancing a business’s credibility and signalling to clients and partners that the business is reliable and committed to fulfilling its obligations. “This is achieved by offering the project owner a safety net that allows the business to be indemnified for the failure of the contractor to complete the work thus mitigating potential financial losses,” Sizakele explains.
When applying for a bond, the business in question (principal) would need to prove to the guarantor that they are a worthwhile risk to back. To ascertain the principal company’s ability to undertake the task at hand successfully, the guarantor will look at the company’s profile, past completed projects, project pipeline, audited financial statements, and management accounts as well as the contract that they are bidding for.
“Businesses with bonds have a competitive advantage as it allows the business to bid on larger and more lucrative projects, setting them apart from competitors who may not have the backing provided by bonds issued by an independent third-party insurer or bank. And because the process of setting up a guarantee facility requires a thorough evaluation of the principal’s financial strength, operations and history, this itself signifies financial stability and governance, and compels the principal to maintain strong financial practices,” says Sizakele.
Which industries stand to benefit from this solution? The list of industry sectors includes, but is not limited to:
Renewable Energy
With rising electricity demands, many countries are turning to clean energy to meet this need, reduce carbon emissions, promote ESG goals, realise long-term cost savings, and reliable power supply which will ensure business continuity. These projects require various guarantees as security for different project stages such as bid bonds, preferred bidder bonds, performance bonds, advance payment bonds, maintenance bonds, operation and maintenance bonds, decommissioning bonds, early termination bonds and so on.
Mining Rehabilitation Guarantees
The National Environmental Management Act, 1998 (NEMA), prescribes that mining companies must provide for land rehabilitation at the end of a mine’s life. This can be achieved using a section 37A trust, a bank guarantee, cash deposited with the Department of Mineral Resources or insurance guarantees issued by approved DMRE insurers.
Construction
Guarantees are prevalent in the construction industry, regardless of the contract type (e.g., FIDIC, NEC, GCC, JBCC). Each contract type has specific guarantee wordings applicable to agreements between the principal and the obligee. The predominant type of guarantee includes bid bonds, Advance payment bonds, performance bonds, retention bonds or maintenance bonds.
Customs & Excise
The South African Revenue Service (SARS) requires guarantees as security against deferment liability for VAT/Duty on imported goods. These are essential for freight forwarders, logistic companies and transporters and include bonded warehouse bonds, deferment bonds, temporary importation bonds and airline bonds.
The Insurance market has evolved throughout the years, from issuing straightforward local insurance guarantees to issuing guarantees on cross-border projects to international beneficiaries using their fronting partners such as insurers and banks.
“It is crucial to work with a professional broker that has the global capabilities and insight to help facilitate the placement of guarantees for local and cross-border projects using a trusted network of insurer partners. Not only will it ensure that the contractor complies with the contractual obligations and legislation within the country, but insurance guarantees are also the most economical as they free up working capital for the business, relying mostly on paper security and minimal collateral if at all,” Sizakele explains.
In a world where trust and reliability are essential for successful business operations, bonds play a crucial role. “They assure that commitments will be met, enhance a business’s working capital management and enable businesses to grow and compete more effectively. For any business looking to leverage this instrument to secure additional liquidity, enhance its credibility and manage risk, insurance bonds are a strategic and necessary decision,” Sizakele concludes.
