Legal Certainty Of Surety Bond In Indonesia

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Kenny Wiston

Introduction
A surety bond is a three-party agreement whereby the surety company guarantees the obligee (owner) that the principal (contractor) will perform a contract.

In construction, contract surety bonds are provided to an obligee (typically the construction project owner) by licensed surety companies that commit their assets to support the performance and financial obligations of the principal (typically the contractor or subcontractor). General contractors may also serve as the obligee when bonding subcontractors. Contract surety bonds are a preferred method of guaranteeing the performance or financial obligations of others. Surety bonds used in construction include bid, performance, and payment bonds as well as supply and maintenance bonds. Construction owners, contractors, lenders, public officials, and others involved in the construction project need to know about the companies that issue surety bonds and the role of the surety bond producer.

There are three primary types of contract surety bonds. The bid bond provides financial assurance that the bid has been submitted in good faith and that the contractor intends to enter the contract at the price bid and provide the required performance and payment bonds. The performance bond protects the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions. The payment bond guarantees that the contractor will pay certain workers, subcontractors, and suppliers.

Unlike other types of insurance, which maintain deductibles and charge premiums based on the probability of expected loss, surety companies do not expect a loss. The surety bond premium is a fee for underwriting or prequalifying the contractor.
In Indonesia, hoever, the surety bond is less popular compared to bank letters of credit. Perhaps, obligees especially foreign investors are reluctant to use this insurance product due to uncertainty in the law in the event of defaults.

This article discusses legal aspects of suretyship in Indonesia especially when default does occur because of failure to perform, many times because the contractor is experiencing some type of insolvency which results in failure to pay subcontractors and suppliers and also provides some tips to prospective surety bond holders in Indonesia as to what rules should be included and/or exempted in a bonded contract before agreeing to accept and conclude the bonded contract in order to secure their claims.

Surety Companies: What They Are & How to Find Out About Them
Contract surety bonds are a preferred method of guaranteeing the performance or financial obligations of others. In construction, contract surety bonds are provided to an obligee (typically the construction project owner) by licensed surety companies that commit their assets to support the performance and financial obligations of the principal (typically the contractor or subcontractor). General contractors may also serve as the obligee when bonding subcontractors. Surety bonds used in construction include bid, performance, and payment bonds as well as supply and maintenance bonds. Construction owners, contractors, lenders, public officials, and others involved in the construction project need to know about the companies that issue surety bonds and the role of the surety bond producer.

What is a Surety Company?
Most large property and casualty insurance companies have surety departments. In addition, there are some companies for which surety bonds make up all or most of their business. In either case, in order for a company to write a surety bond in the United States, it must be licensed by the insurance department of one or more states. Although there are some exceptions, generally a surety company must be licensed by the state in which it is doing business or by the state where the obligation guaranteed by the bond is being performed.

It is the surety company’s thorough prequalification process that greatly reduces the likelihood of contractor default. The surety company underwriter takes an in-depth look at the contractor’s entire business operations – credit history and financial strength, experience, equipment, work in progress, and management capability – and must be satisfied that the contractor is capable of completing the project before issuing a bond. Should the contractor experience difficulties on a project, it is possible for the surety company to assist the contractor before a default occurs. Surety companies may offer financial assistance or technical expertise to get a project back on track. The owner may not even be aware of the surety’s involvement.

In the unfortunate event that the owner declares the contractor in default, the surety must investigate the claim, analyze all options, and choose a course of action. If the contractor is in a default situation, the surety may finance the original contractor or provide support to ensure project completion, arrange for a new contractor to complete the project, or pay the cost of completion.

In America, information about surety companies can be obtained from The Surety Association of America (SAA), (202) 463-0600, www.surety.org. SAA is a voluntary, non-profit, association of companies engaged in the business of suretyship. It presently has approximately 650 member companies that collectively underwrite the overwhelming majority of surety and fidelity bonds written in the United States. SAA is licensed as a rating or advisory organization in all states, District of Columbia, and Puerto Rico and has been designated by all state insurance departments except Texas as a statistical agent for the reporting of fidelity and surety experience. SAA represents its member companies before federal, state, and local government agencies.

Other sources of information about surety companies include:
Surety Bond Producers;
State Insurance Departments;
U.S. Department of the Treasury; and
A.M. Best Company

In Indonesia, there are only twenty two licensed companies which may issue surety bonds. This is based on the decision of the Minister of Finance No.761/KMK. 013/1992 and the Circular Letter of the Director of Insurance No. s.2272/DK/2001 dated 16 May 2001. In addition, there are only fifteen licensed insurance companies which may issue custom bonds by virtue of the decision of the Minister of Finance no.108/KMK.01/1995. You can check the listed companies attached to those ministerial decisions should you need to find out the names and details of the companies.

What Is the Role of a Surety Bond Producer?
Most surety bonds are issued through surety bond producers, also known as agents and brokers, who are knowledgeable about the surety and construction industries. Surety bond producers usually work in agencies that specialize in surety bonds or in insurance agencies that have a sub-specialty in surety bonds. In many instances, surety companies rely on surety bond producers to keep them informed of local and regional construction activities and trends. The professional surety bond producer usually maintains a business relationship with several surety companies, which enables the producer to match a contractor with an appropriate surety company.

The surety bond producer may help a contractor obtain surety bonds, and provide business advice, management consulting and technical expertise. The producer is an integral part of the contractor’s external advisory group, which may also include attorneys, bank officers, and auditors. By using his/her specialized knowledge of the construction industry, the producer assists the contractor in preparing for the surety company’s rigorous prequalification process. As a contractor develops a strong business relationship with a surety bond producer, a relationship will also develop between the contractor and surety company. A good surety company and surety bond producer will help a contractor maintain and increase its surety capacity.

Licensed Surety Companies in Indonesia

As stated above, the ground on which surety companies may issue surety bonds in construction works and trade financed by APBN is the decision of the Minister of Finance KMK RI no. 761/KMK.013/1992. In addition, the ground on which surety companies may issue customs bonds is the decision of the Minister of Finance KMK RI No. 108/KMK.01/1995. However, these ministerial decisions do not contemplate and elaborate the principles and procedures of issuing such surety bonds, but as called by the Minister of Finance, the principles per se should refer to the principles of insurance businesses set out by Law No. 22 of 1992.
Things You Should Know About Surety Bonding
An owner wants a contractor who runs a well-managed, profitable enterprise, keeps promises, deals fairly, and performs obligations in a timely manner. Prequalification of the contractor for a surety bond provides these assurances to the owner. The owner also wants protection in the event the contractor, for some reason, defaults on the contract. Surety bonds provide that protection.

1. The surety company’s financial resources are used to back the contractor’s commitment to completing the contract, thus enabling the contractor to acquire a contract with an owner. The owner receives guarantees from a financially responsible surety company licensed to transact suretyship that the contract will be fulfilled. Unlike other types of insurance, which maintain deductibles and charge premiums based on the probability of expected loss, surety companies do not expect a loss. The surety bond premium is a fee for underwriting or prequalifying the contractor.

2. The surety company’s rigorous prequalification of the contractor protects the owner and offers assurance to the lender, architect, and everyone else involved with the project that the contractor is able to translate the project’s plans into a finished project. Surety companies and surety bond producers have been evaluating contractor and subcontractor performance for more than a century. Their expertise, experience, and objectivity in prequalifying contractors is one of a bond’s strongest attributes. Before issuing a bond, the surety company must be fully satisfied, among other criteria, that the contractor has:
good references;
experience matching the requirements of the contract;
the ability to obtain the necessary equipment to do the work;
the financial strength to support the desired work program;
an excellent credit history; and
an established bank relationship and line of credit.

3. Construction is a very risky business. According to Dun & Bradstreet’s Business Failure Record, an average of 10,000 contractors fail each year, leaving a trail of unfinished private and public construction projects. Surety bonds offer assurance that the contractor is capable of completing the contract on time, within budget, and according to specifications. Specifying bonds not only reduces the likelihood of default, but with a surety bond, the owner has the peace of mind that a sufficient risk transfer mechanism is in place. The risks of construction are shifted from the owner to the surety company. If the owner declares the contractor in default, the surety then investigates.

4. Contractor default is an unfortunate, and sometimes unavoidable, circumstance. In the event of contractor failure, the owner must formally declare the contractor in default. The surety will conduct an impartial investigation before taking any action to avoid taking away the contractor’s legal recourse in the event that the owner improperly declares the contractor in default. When there is a proper default, the surety’s options often are spelled out in the bond. These options may include the right to re-bid the job for completion, bring in a replacement contractor, provide financial and/or technical assistance to the existing contractor, or pay the penal sum of the bond.

5. The cost of a performance bond is a one-time premium, which typically ranges from 0.5-2% of the contract amount, depending on the size and type of the project and the contractor’s bonding capacity. There is often no charge for the bid bond, and the payment bond may be issued at no additional charge when issued in conjunction with a performance bond.

6. To bond a project, the owner specifies the bonding requirements in the contract documents. Obtaining bonds and delivering them to the owner is the responsibility of the contractor who will consult with a surety bond producer.

7. Contract surety bonds:
assure project completion;
assure a qualified contractor on the project;
guarantee that the laborers, suppliers, and subcontractors will be paid;
relieve the private owner from the risk of financial loss arising from liens filed by unpaid laborers, suppliers, and subcontractors;
smooth the transition from construction to permanent financing by eliminating liens on private projects ;
help the contractor grow by increasing construction project opportunities and offering assistance and advice;
provide intermediaries – the surety company and surety bond producer – to whom the owner can air complaints and grievances;
lower the cost of construction in some cases by facilitating the use of competitive bids; and
Screen out unqualified contractors and irresponsible competition.

Surety bonds are an integral part of the construction process and should be considered by every owner undertaking such a risky venture.

Surety Bonds v Bank Letters of Credit
Although surety bonding is a part of the insurance industry, it shares some characteristics of bank credit. The surety company’s primary obligation is not to lend the contractor money. Rather, the surety company’s financial resources are used to back the contractor’s commitment to completing the contract, thus enabling the contractor to acquire a contract with an owner.

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