Surety Bond Instead Of Bank Guarantee 22 August 2019

The Notion of “Surety Bond” was firstly introduced to Turkish legal system in 2014 by the publishing of Surety Bond General Conditions (“General Conditions”) by the Undersecretariat of Treasury. Surety bond, which is a substitute for bank guarantees, has been used globally over 75 years to meet the needs of private sector for guarantee and accordingly, to provide a comfort to the same by allocating the current bank credit line to their other activities. Lately, surety bond was accepted as a guarantee type under Public Tender Law by the amendment of Article 4 of such Law on 2017 and became more popular since then. 

Due to the latest financial instabilities in Turkey, the banks currently refrain from opening non-cash loans to issue a bank guarantee for their clients.  This situation mostly affects the public tenders, since the submissions of the provisional bank guarantees to the tender files becomes significantly difficult which delays the tender procedures. At this point, insurance companies fill in for the banks and issue surety bonds in substitution for bank guarantees.

Surety insurance consists of three parties which are insurer, insured and beneficiary. The insurer provides a guarantee for the risk of failure of insured to fulfill its obligations against beneficiary in legal relation between the beneficiary and insured against the insurance premium to be paid by the insured. The insurance company makes a risk assessment and issues the surety bond upon the advance payment of the insurance premium. Accordingly, termination/cancellation of the surety bond due to non-payment of the premium shall not be possible. 

Issuance of a surety bond has two phases. In the first phase, an umbrella agreement is signed by and between the insurer and the insured and accordingly, the due and non-due payment obligations of the insured is guaranteed by the insurer. In the second phase, a surety bond is issued by insurer under such umbrella agreement and submitted to the collector of the insured party.  

Above mentioned umbrella agreement may be unilaterally terminated by either of the parties. However, even if the umbrella agreement is terminated within the validity periods of the surety bonds which were previously issued under such umbrella agreement, the surety bonds will continue to be effective and accordingly, the guarantee obligations of the insurer against the beneficiaries (collectors of the insured) shall still be valid. At this point, there will be no risk for the collectors of the insured party.

Surety bonds may be issued for several guarantee types, such as advance payment guarantee, payment guarantee, performance guarantee or contract guarantee.  The important point here is whether the surety bond is issued as conditional or non-conditional.

Some surety bonds are issued in non-conditional and payable on demand nature. If the surety bond is non-conditional, the insurer should make the respective payment to the beneficiary open his demand without making any investigation on the legitimacy of such payment claim. The insurer cannot reject to pay the compensation amount to the beneficiary by making the pleas of the insured party and also cannot make any investigation on whether the beneficiary has a legitimate ground for such request. The insurer may only reject payment by claiming fraud or making his personal pleas.

In case the surety bond is issued as conditional, the insurer shall have the right to investigate whether the insured has failed to fulfill its obligations and necessary evidences are submitted to provide such failure. Otherwise, the insurer may reject to make the make the necessary compensation payment.

Although conditional surety bonds differ from bank guarantees, non-conditional surety bonds provide the same legal protection with bank guarantees. Consequently; acceptance of the surety bonds as a guarantee instrument within Turkish legal system has prevented financial and administrative problems confronted by the debtors as a result of rejection of banks to issue bank guarantees and accordingly, surety bonds have become an alternative project financing instrument in lieu of bank guarantees.