The Central Government plans to give the insurers of the infrastructure project the status of financial creditors under the Insolvency and Bankruptcy Code, 2016. The announcement came amidst the government’s push to enhance the use of the surety insurance bond in the infrastructure sector. The Indian government is emphasizing the use of the surety insurance bond in order to replace the traditional system of bank guarantees. The benefit of the surety insurance bond is that the contractor will not have to pledge a huge amount of collateral to avail themselves of the bond, as they have to do so when contracting the bank guarantee. This will increase the availability of funds for the contractors to invest in the project.
Such change brings with it many complexities and legal hurdles; thus, the article aims topropose practical solutions within existing legal frameworks. It further seeks to foster insurer confidence, promote their active role in infrastructure financing, and facilitate a smoother integration into the insolvency resolution landscape
Need for Financial Creditor status for insurance companies.
Surety bond insurance is a tripartite contract in which the insurance company acts as a guarantor for the contractor. Under this contract, if the contractor fails to perform its obligations under the contract, the other party will have the right to invoke the bond insurance and to claim the amount of damages arising from the breach from the insurance company that has been provided in the bond.
The need to give the status of financial creditors to insurers for infrastructure is important because of the waterfall mechanism mentioned under section 53 of the IBC. As per this mechanism, the claims of the financial creditors must be satisfied, and it is only after the claims are satisfied that the remaining amount is distributed among the operational creditors. Moreover, under the code, it is only the financial creditors that have the authority to accept or reject the resolution plan. Therefore, in order to give effective assurance to the insurers of infrastructure projects regarding the security of their money, the insurers must be treated as financial creditors under the code.
Challenges in granting financial creditor status to Insurance Companies
Considering the current regulatory framework of the surety insurance bond, problems will arise in treating the insurers as financial creditors under the Insolvency Law. The first problem that will arise is that as per the guidelines issued by the Insurance Regulatory and Development Authority of India, a surety insurance bond is a contract of guarantee under Section 126 of the Indian Contract Act, 1872.
In Lalit Kumar Jain v, IBBI, the Supreme Court held that the principle of subrogation as enshrined under Section 140 of the ICA will be applicable to the claims of the guarantors. It means that when the guarantor discharges the debt of the corporate guarantor, the guarantor gets all the rights the creditors have against the corporate debtor. In the case of the surety bond, the insurer guarantees for the completion of the project. In this case, the insurance company will get the rights of the party that has availed of the services of the contractor for the infrastructure project.The disadvantage of this is that since the infrastructure contract has arisen in the course of the business, it is possible that the insurer who is the guarantor would be regarded as the operational creditor, because, as per Section 5(21) of the IBC Code, a debt will be treated as the operational debt if it has arisen in respect of the provision of the supply of goods and services.
Granting operational creditor status to insurance companies would subordinate their claims to other financial creditors, limiting their decision-making authority in company resolutions. The difficulty arises because, although the surety insurance bond is executed for infrastructure projects, the court may categorize insurers as operational creditors due to the contractual nature of supplying insurance bonds, perceived as selling a product. This distinction is rooted in the essence of insurance companies selling bonds to contractors in exchange for a premium, aligning with the definition of operational debt.
Moreover, another problem that will arise is that the issuance of the surety insurance bond will not fall under the ambit of the financial debt as defined under Section 5(8) of the code. In the case of Orator Mktg (P) Ltd v. SamtexDesinz, the Supreme Court clarified that any debt cannot be deemed to be a financial debt under the code unless it has satisfied the criteria of the time-value of money. Further, in Pioneer Urban Land Ltd v. Union of India, the court defined the time-value of money as the additional return that the creditor must get in return for the supply of the money. Since, under the Surety Insurance Bond, the insurer can claim only that amount from the corporate debtor that it has provided to the principal as provided in the bond, thus, there is no element of time-value of money involved, therefore, the insurers cannot be deemed to be the financial creditor under the code.
The primary source for most of these problems lie in how we categorize financial debt. Since the definition of “financial debt” covers counter-indemnity contracts, but such debt is categorized as “financial debt” only when issued by banks or financial institutions, as specified in Section 3(14) of the code. Insurance companies are notably absent from the list of financial institutions, aligning with the legislative intent.In Swiss Ribbons v. Union of India, it was explained thatthe distinction lies in the nature of investment; while financial creditors invest and assess financial viability, insurance companies, focused on selling products, do not earn profits from interest or dividends. The tax treatment under the Goods and Services Tax Act further emphasizes the legislative view of insurance as a service providing indemnity for a premium, rather than an investment.
The principle laid down in Pioneer Urban Case regarding the financial debt can be invoked to deal with the challenges mentioned above. In this case, the court has held that the homebuyers would be a financial creditor under the code despite not getting any extra return on money on the ground that the money that homebuyers provided to the real-estate developers should be regarded as money provided for the home. The court analyzed the increase in the value of a home over the period as the time value, thus considering the money lent for construction as the financial debt.
The ratio can be extended here as creditors enter into the infrastructure contract with the contractor at a pre-determined price before the beginning of the project. The creditors enters into such pre-determined price and pays the advance money with the intention to get additional return on their money as the cost of the project will get increased in the future. Thus, the difference in cost that the creditors will get, falls under the ambit of the “time-value of money.”The application of Pioneer Urban’s case will give the creditors under the ambit of the financial creditors because money advanced for the infrastructure contract will be a financial debt.
In extension to this, to solve the problem of time-value of money, the IRDAI exercising power under the section 14(2)(i) of IRDAI act should mandate that surety insurance bond must have a clause that if the insurance company discharges the bond amount, it is entitled to interest. The clause for providing the interest is essential as it signifies the profit or return that the insurance companies will get on discharging the bond amount that coming under time-value of money. The premium that insurance companies would charge for issuing the surety insurance bond cannot be treated as the time-value of money as it is charged in return for the service of issuing the bond and it could not be said to time value of money as it is received even before the money is paid by the insurer to the contractor.
These solutions also agree with established positions of law, such asOrbit Tower Pvt Ltd v. Sampurna Suppliers Pvt Ltd where it has been declared that the on discharging the debt of the principal debtor, the guarantor will get all the rights and status of the creditors. Since the insurers would provide money to the contractor in case of breach, the insures will become the financial creditors by applying the principle of subrogation. Moreover, in order to avoid the disputes that might arise in interpreting the term “infrastructure project”, the author suggests the list of infrastructure projects provided under the Specific Relief Act, 1963 should be considered as an exhaustive list of the infrastructure projects.
Conclusion and Way Forward
The government’s initiative to confer financial creditor status to the insurance companies issuing the Surety Insurance bond is a commendable step. The move will ensure that the companies will be more willing to provide finance to the infrastructure projects as they will have the first preference in getting their claims been paid off and they will also have the say in determining the fate of the corporate debtor. While embarking on such an endeavor, the government must be careful to operate within the confined of the existing law, and prevent opening of a new pandora of problems.
(This post has been authored by Priyansh Bharadwaj, a 4th year student of Dharmashastra National Law University, Jabalpur.)
CITE AS: Priyansh Bharadwaj, ‘Surety Insurance Bond – A Financial Debt?’ (The Contemporary Law Forum, 24 December 2023)