Case Premise

TOP COMPANY construction Ltd was recently awarded a public works contract by the National Highway Authority of India (NHAI) for the construction of a new highway in Gujarat, India.

The project was expected to take approximately two years to complete and was valued at Rs.500 crores. As part of the bid process, the construction company was required to obtain a performance guarantee in the amount of Rs.25 crores. This guarantee was provided by a leading insurance company, which guaranteed TOP COMPANY construction Ltd.’s performance on the project. The TOP COMPANY construction limited pondered upon options between Bank Guarantee from State National Bank (SNB) & Surety Bond from the Insurance Company.

Choice between Bank Guarantee and Surety Bonds for contractors

Comparison: Bank Guarantees vs Surety Bonds

Ultimately, the comparison yielded the following results :

Bank Guarantees vs Surety Bonds: A comparison.

Considering the differences between Bank Guarantees & Surety Bonds, the Principal and the Contractor decided that it was best to go ahead with a Surety bond with a customized Surety Bond Insurance as per the contractual agreement between NHAI & TOP COMPANY. Both the Principal and the Contractor were happy with this decision.

In fact, SNB was also happy with this decision as it had previously encountered many losses in issuing Bank Guarantees, in part, due to its inability to manage risks as effectively as Insurance company. Now, SNB could focus on better money generating opportunities with less risks. TOP COMPANY was also utilizing the Line of Credit (fund based) extended by SNB to full effect now. This strengthened the relationship between the Bank & the Construction Company.

Pricing: Bank Guarantees vs Surety Bonds

Pricing of Bank Guarantees vs Surety Bonds. Lost opportunity cost of cash margins and collaterals required by banks

The surety bond amount was based on a percentage of the total project value, which is typical in the construction industry. In this case, the bond represented 5% of the project value, which is on the higher end of the typical range of 3-20%.

The TOP COMPANY construction had strong financials, including a solid track record of completing projects on time and within budget, and a strong balance sheet with low levels of debt. It performed well on all parameters of Surety Company which are the Capacity, Capital & Character (3Cs).

These factors allowed the Insurance Company to provide the bond at the price of 2%, which is also within the typical range of 0.5-5% of the bond amount, as they demonstrated the construction company’s ability to fulfil its obligations on the project.

Conclusion: A decision for the contractors

Throughout the construction process, the construction company encountered several challenges, including delays due to inclement weather and issues with the supply chain. Despite these challenges, the company was able to complete the project on time and within budget, thanks in part to the financial backing of the performance bond. The use of the performance bond helped to protect the government’s investment in the project and ensured that the construction company was held accountable for delivering high-quality work. It also helped to build trust and confidence between the government and the construction company, as both parties knew that the bond was in place to protect against any potential issues that might arise during the construction process.

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