This white paper examines the current challenges faced by Indian insurance companies issuing surety bonds, particularly as they are classified as unsecured creditors under the Insolvency and Bankruptcy Code (IBC) 2016. This classification limits their recovery prospects in insolvency scenarios. To navigate these challenges, insurers increasingly rely on indemnity agreements with contractors (the indemnifiers) to secure their interests. These agreements enable direct, enforceable claims against contractors upon default, allowing for faster and more efficient recovery than the IBC process.

Using case studies and a detailed comparison of recovery options, this paper demonstrates that indemnity agreements provide insurers with a practical, effective mechanism for mitigating surety bond risks. This white paper aims to convince reinsurance companies that indemnity agreements are a valuable tool, providing reliable recovery for insurers and offering robust protection in the context of surety bond obligations.

1. Introduction

In India, insurance companies play a critical role in facilitating public and infrastructure projects by issuing surety bonds on behalf of contractors. These bonds, required by entities such as the National Highways Authority of India (NHAI), NTPC, and other Central Public Sector Enterprises (CPSEs), serve to guarantee contractor performance. However, if a contractor defaults, insurance companies must pay the claim to the beneficiary and then seek recovery from the contractor. The IBC 2016 complicates this recovery, as it classifies insurers as unsecured creditors, limiting their recovery rights in the event of contractor insolvency.

To mitigate these limitations, insurers increasingly rely on indemnity agreements. By establishing a direct obligation for contractors to reimburse insurers, these agreements offer a powerful recovery mechanism that bypasses the restrictions of unsecured creditor status. This white paper explores why indemnity agreements provide superior recovery potential, even if insurers were to gain secured creditor status under the IBC, supported by real-world examples and comparative analysis.

2. The Current Legal Landscape: Insurance Companies as Unsecured Creditors under IBC

2.1 Limitations of Unsecured Creditor Status

Under IBC, creditors are classified into secured and unsecured categories, with secured creditors having priority in asset distribution during insolvency proceedings. Because insurance companies are classified as unsecured creditors, their recovery prospects are often limited. Given the priority hierarchy, unsecured creditors typically recover less and face significant delays in repayment.

2.2 Indemnity Agreements as a Strategic Alternative

In response, insurance companies are increasingly using indemnity agreements when issuing surety bonds. These agreements legally bind contractors (indemnifiers) to reimburse the insurer for claims paid to beneficiaries in case of default. Indemnity agreements, when well-drafted, enable insurers to bypass the limitations of unsecured status by enforcing direct claims against indemnifiers, ensuring faster recovery without the need to wait for insolvency proceedings.

3. Case Studies: Effective Recovery through Indemnity Agreements

3.1 Insurance Sector Case Studies

Oriental Insurance Co. Ltd. vs Kajaria (2007)

- Background: Oriental Insurance issued a surety bond for a construction project on behalf of a contractor. When the contractor defaulted, Oriental invoked the indemnity agreement with Kajaria, the indemnifier, to recover its losses.
- Outcome: The court upheld the indemnity clause, allowing Oriental Insurance to secure recovery directly. This case demonstrates that indemnity agreements provide a practical route for insurers, ensuring recovery outside of lengthy IBC procedures.

Adamji Lookmanji & Co. vs Bombay Fire and Marine Insurance Co. Ltd. (1966)

- Background: Bombay Fire and Marine Insurance issued a surety bond and later sought indemnity from the contractor. The insurer successfully invoked the indemnity agreement, and the court upheld the indemnifier’s obligation to compensate the insurer.
- Outcome: This case illustrates that indemnity contracts are enforceable against both corporate and individual indemnifiers, allowing insurers to pursue recovery outside IBC’s unsecured classification.

3.2 Banking and NBFC Sector Examples

State Bank of India vs General Engineering Company (2010)

- Background: SBI issued a loan to General Engineering Company, secured by an indemnity agreement with the company’s promoters. When the company defaulted, SBI enforced the indemnity directly against the promoters, sidestepping the insolvency process.
- Outcome: SBI recovered a substantial amount by attaching the promoters’ personal assets. This demonstrates that indemnity agreements are a reliable recovery tool, enabling creditors to bypass IBC proceedings and obtain direct payment from indemnifiers.

HDFC Bank vs Precision Pipes (2015)

- Background: HDFC Bank provided financing to Precision Pipes, secured by an indemnity agreement with the company’s directors. Following a default, HDFC enforced the indemnity, securing recovery directly from the directors without resorting to insolvency proceedings.
- Outcome: HDFC achieved faster recovery and avoided typical IBC delays, proving that indemnity agreements offer a dependable and timely recovery mechanism for creditors.

4. Comparative Analysis: Why Indemnity Agreements Offer Superior Recovery Potential

4.1 Poor Recovery Experiences under IBC 2016

While the IBC process was designed to improve insolvency resolution, the experience of many secured creditors has highlighted significant limitations, especially in cases where asset values fall short or timelines exceed the prescribed limits. Even secured creditors have reported diluted recoveries and protracted timelines, making the IBC a less efficient recovery pathway.

Examples of Limited Recoveries under IBC

Essar Steel Case (Standard Chartered Bank vs Satish Kumar Gupta, 2019):

- Background: Essar Steel’s insolvency resolution became a landmark IBC case, but the process took nearly three years, well beyond the prescribed 330 days.
- Outcome: Secured creditors, including Standard Chartered Bank, faced protracted delays and, despite their priority, saw reduced recovery amounts due to extensive creditor negotiations and restructuring considerations. This case underscores the lengthy and often unpredictable nature of IBC proceedings.

Jaypee Infratech Insolvency Case (2017):

- Background: Jaypee Infratech’s insolvency impacted thousands of creditors, including secured ones. Delays and complex stakeholder coordination led to further setbacks, stretching over five years without a final resolution.
- Outcome: Secured creditors suffered substantial losses in value due to prolonged asset depreciation and insufficient assets, illustrating the high risks and poor recovery potential even for secured creditors under IBC.

These cases highlight that even secured creditors under IBC often experience suboptimal recovery outcomes, reinforcing that relying on the IBC as a primary recovery mechanism can be inefficient. This comparison underscores the advantage of indemnity agreements, which offer direct, timely, and often full recovery without these procedural setbacks.

4.2 Comprehensive Comparison Table

Factor	Indemnity Agreement	IBC as Unsecured Creditor	IBC with Secured Creditor Status
Priority of Recovery	Direct claim against indemnifier with no competition	Lower priority after secured creditors	Priority over unsecured creditors but not other secured ones
Control Over Process	Insurer maintains full control over enforcement	Limited control, subject to NCLT’s structured process	Moderate control; part of creditor committee decisions
Timeliness of Recovery	Immediate upon liability trigger	Often delayed due to insolvency resolution timeline	Dependent on resolution plan, may be delayed
Cost Efficiency	Lower legal and enforcement costs	Higher administrative and legal costs	High, due to procedural and legal expenses
Flexibility in Enforcement	Insurers can customize recovery (e.g., garnishment, asset attachment)	Restricted by structured IBC process	Some flexibility, but limited by collective decisions
Reliability of Recovery Amount	Full amount recoverable if indemnifier’s assets are sufficient	Typically diluted, especially if assets are scarce	Better recovery but diluted in multi-creditor scenarios
Stakeholder Involvement	Minimal (only insurer and indemnifier involved)	Multiple stakeholders, including creditors and resolution professionals	Multiple stakeholders, requires coordination
Legal Basis and Precedents	Strong case law supporting enforceability of indemnity agreements	IBC has precedence but favors secured creditors	Secured status improves recovery but not fully certain

5. Hypothetical Scenario: Insurance Companies as Secured Creditors under IBC

If insurers were granted secured creditor status, they would gain higher priority in asset distribution under IBC. However, the collective nature of IBC proceedings still limits the timeliness and amount of recovery, as asset distribution depends on the committee’s resolution plans and restructuring processes. Even as secured creditors, insurers would face the inherent delays and cost implications of IBC, making indemnity agreements a preferable recovery tool.

6. Recommendations for Reinsurance Companies

To support insurance companies’ efforts in issuing surety bonds, reinsurance companies should consider the following:

Emphasize Robust Indemnity Agreements: Reinsurers should work with insurers to ensure that indemnity agreements are comprehensive and enforceable. These agreements should include clear liability triggers, asset attachment provisions, and immediate enforceability clauses.
Collaborative Financial Assessment: Reinsurers can support insurers in assessing the financial stability of indemnifiers to ensure their capacity to meet indemnity obligations if claims arise.
Highlight Case-Based Evidence: Citing case examples where banks, NBFCs, and insurance companies have successfully recovered dues through indemnity agreements, reinsurers can feel reassured that indemnity agreements provide reliable recovery outside of IBC constraints.

7. Conclusion

Indemnity agreements offer insurance companies a more effective, timely, and flexible recovery mechanism for surety bonds than IBC proceedings. Given the limitations of IBC’s unsecured status and the inherent delays in insolvency resolution, indemnity agreements enable insurers to bypass lengthy procedures and secure direct recovery from indemnifiers. Even if insurance companies were to gain secured creditor status under IBC, indemnity agreements would remain a preferable approach due to their enforceability, cost efficiency, and control over the recovery process.

For reinsurance companies, supporting robust indemnity agreements ensures that insurers have a practical and effective safeguard in place for surety bond recoveries. The experiences of banks, NBFCs, and insurers alike demonstrate the superiority of indemnity agreements in providing a secure, reliable recovery pathway, reinforcing their importance in risk management for surety bonds.