The New Legal Framework for biddings and Administrative Agreements - What Impact Does This Have on the Surety Bonds

On 1st April 2021, President Jair Bolsonaro approved the long-expected new legal framework for biddings and administrative agreements (“New Legal Framework for Biddings”), by means of Law No. 14,133/2021.

After 25 years of discussions in the National Congress, on 10th December 2020, Bill of Law No. 4,253/2020 was approved by the Federal Senate, revoking the connected provisions in the existing Law No. 8,666/93, relating to Bidding Procedures and Administrative Contracts, and in Law No. 10,520/02, relating to Tender Procedures and Law No. 12,426/11, relating to Special Contracting Regimes.

Although it came into effect on the date of its publication, the New Legal Framework for Biddings provides for a vacatio legis period of two (2) years, which will be essential for public agents and private entities to adapt to the changes introduced by the new legal text in public procurement.

The vacatio legis will also be important for the adaptation of insurance companies, which will be directly affected by the new legal provisions regarding the issuance of surety bonds, as well as for the Brazilian (Re)Insurance Authority - SUSEP, which is already working on the amendment of Circular SUSEP No. 477/2013 (“SUSEP Circular 477”), that governs Surety Bonds and their standardized conditions for policy wording.

As it was the case in Law No. 8.666/93, the New Legal Framework for Biddings sets forth that the competent authority will have discretion to require the provision of a guarantee for the performance of contracting of works, services and supplies; in such case the contractor may be able to choose among three types of guarantees, as contemplated in the first paragraph of Section 96, namely a security deposit in cash, a bank guarantee and a surety bond.

By the new definition, a surety bond is the insurance that ensures the faithful compliance of the obligations undertaken by a contractor. The former definition, contrarily, restricted to guaranteeing the obligations assumed by companies, as established in Section 6 of Law No. 8.666/93. This guarantee may be used even by individuals, which can bring business opportunities for the insurance market. In turn, the new definition fails to be accurate by not comprising the types of surety bonds possible in the biddings, when the contractor is not yet defined and determined.

In addition, the New Legal Framework for Biddings establishes that the purpose of a surety bond is “the faithful compliance of the obligations undertaken by the contractor vis-à-vis the Government, including fines, losses and damages resulting from default, subject to the following rules contemplated in the agreements governed by this Law (...)

As it can be seen, the lawmakers created confusion when defining the purpose of surety bond, by stating that this insurance guarantees the compliance of obligations undertaken by the contractor, as well as fines, losses, and damages arising from default.

This confusion makes it difficult to understand the purpose of this insurance, since the risk against which the guarantee is contracted is strictly limited to the lack of compliance with the contractual obligation, which, in turn, can result in losses and fines. These consequences are either repaired or paid for by the insurer by means of the indemnification.

One of the most awaited changes brought by the New Legal Framework for Biddings was the increase in the proportional value of the guarantee.

According to the Law No. 8.666/93, the value of the guarantee could not exceed 5% of the contract value. Only for works, services and supplies of great magnitude involving high technical complexity and considerable financial risks, provided it was demonstrated through an opinion technically approved by the competent authority, could be raised to up to 10%. 

Now, under the New Legal Framework for Biddings , it will be 5% of the initial contract value, and this percentage may be increased up to 10%, provided it is justified by the technical complexity and risks involved. 

Moreover, the percentage of the guarantee in major engineering works and services will now be up to 30% (thirty percent) of the initial contract value. The Law No. 14.133/2021 considers “major” as such those engineering works and services which estimated value exceeds BRL 200,000,000.00 (two hundred million reais).

And why is this change in the bidding regime so relevant to the insurance market? The lawmaker determined that no other type of guarantee except the surety bond may exceed the limit of 10% of the initial value of the contract, reaching the 30% level, removing the contractor’s prerogative to opt for another type of guarantee, such as, for example, the cash deposit and the bank guarantee. The justification is revealed by the concern with the countless unfinished works spread throughout Brazil and the solution offered by surety bonds. Only this, in case of default by the contractor, allows the guarantor, in this case the insurance company, to take over the performance and completion of the object of the agreement. This mechanism is called “step-in clause”, provided for in section 102 of this law.

The step-in, known in Portuguese as resumption clause, has been provided for in the Brazilian legal system since 2015, by means of Law No. 13,097, which amended the wording of Law No. 8987/1995, relating to Concession Agreements, and the Public-Private Partnerships Law No. 11,079/2004, which provided for the possibility of lenders and guarantors of a project to assume the control or temporary management of the concessionaire to promote its financial restructuring and ensure the continuity of services rendered.

Under the scope of surety bonds, SUSEP Circular 477 already provided for the possibility of the insurer performing the object of the guaranteed contract in the event of default by the contracted party in lieu of indemnifying in cash for the losses experienced by the contracting party.

In turn, although the step-in was already legally allowed, the formalization of this mechanism in the New Legal Framework for Biddings brings more legal security to the players involved in this contractual relationship and plays an important role in safeguarding the delivery of works for the development and growth of the country.

If provided for in the bid notice, the resumption of the work by the insurers holding the risk is not mandatory, since the new legal wording grants discretion to the insurer to choose between stepping-in and carrying out and completing the work agreed under the agreement or paying the full sum insured under the policy.

It is important to point out that the New Legal Framework for Biddings does not condition the step-in clause only to major works and services, leaving the possibility for the government to step-in instead in its bid notices relating to works and engineering services of different sizes.

In view of the recent presidential approval of Bill of Law No. 4,253/20, it is expected that SUSEP will amend the wording of SUSEP Circular 477, in order to give more freedom to the insurance market as to the development of the instrumentation of surety bonds.

In this context, it is worth mentioning that only three days before the publication of the New Legal Framework for Biddings, Resolution No. 407/2021 of the National Council of Private Insurance (CNSP) was published providing on the principles and general characteristics for the preparation and commercialization of large risks non-life insurance - which has as its main purpose to provide greater contractual freedom in large risk insurance, granting the parties involved the freedom to compromise, develop and create contractual clauses in their insurance contracts.

The great innovation brought by this rule revolutionizes surety bonds under the light of the New Legal Framework for Biddings, to the extent that it provides that surety bonds may also be classified as large risks insurance, as long as it is purchased by legal entities that present, at the time of purchase or renewal, at least one of the following characteristics:

a) maximum policy limit higher than BRL 15,000,000.00 (fifteen million reais);

b) total assets exceeding BRL 27,000,000.00 (twenty-seven million reais), in the immediately preceding fiscal year; or

c) annual gross revenue exceeding BRL 57,000,000.00 (fifty-seven million reais), in the immediately previous fiscal year.

In the specific case of surety bonds, the contract can also be classified as insurance of large risks if the policyholder or insured pertain to an economic group that meets the provisions contained in items “b” and “c” above, and the policy shall mention expressly the existing link, in a clear and objective manner between them.

Thus, the contractual freedom granted by CNSP Resolution 407/2021 is a factor that may benefit the exercise of stepping-in and will serve as a tool for insurers to limit and minimize the risks involved in the step-in. It should be noted that the expected amendment to SUSEP Circular 477 may establish some special system when it involves the Government in contracts of non-life large risks insurance.

In view of the risks inherent to surety bonds and the risks connected to a step-in clause, insurers will adopt a more active follow up and monitoring of engineering works and services they insure.

Another highlight of the New Legal Framework for Biddings is the possibility of providing for a risk matrix, which consists of a contractual clause defining the risks and responsibilities between the parties and characterizing the initial economic-financial balance of the contract, in terms of the financial burden resulting from events occurring after the purchase of the insurance.

The risks should be allocated between contracting party and contractor, by indicating those to be assumed by the public or private sector or those to be shared. The risks that have coverage offered by insurance companies will be preferentially transferred to the contractor.

In other words, one of the main tools to be used for risk mitigation is the INSURANCE contract itself, regardless of its line of business (engineering risks and general liability, transport, professional liability and even environmental liability insurance), as well as other types of surety bonds.

Therefore, the New Legal Framework for Biddings will not only revolutionize the way surety bonds currently operate, but also represents the creation of new opportunities for the entire insurance market.