Latin American construction bond insurers look to force majeure for respite

old colrful construction helmets

The coronavirus pandemic has affected certain areas of the regional re/insurance market more than others, with construction insurers and reinsurers particularly exposed.

Covid-19 has had an impact on the regional insurance market in Latin America in various ways. For example, in terms of coverage disputes, there has been a notable acceleration in settlement agreements in the region being reached (and paid) by the market to provide certainty and funds in the pocket of insureds. Matters already entrenched and in litigation or arbitration have normally seen a stay of procedural time periods, giving the parties more time to prepare submissions and expert reports, but also creating opportunities to reflect and start dialogue.

Insurance markets in the region are monitoring the UK Financial Conduct Authority’s “test case” of the validity of business interruption claims in the UK with great interest. While the outcome of the court action will not have any jurisprudential effect in Latin America, the decision will certainly be illustrative throughout the region.

There has been a slowdown in expected legislation as a result of the pandemic. With regard to cyber, for instance, the enforcement of the much-expected data protection legislation in Brazil has now been postponed until 2021, with re/insurers adapting their risk perception accordingly.

We have also seen an uptake in client requests in the region with regard to specific legislation/regulation on a wide array of industries ranging from hotels to ports, airports and the Panama Canal, whether on very local issues or international trade alike, in anticipation of conversations with global insureds about how to adapt to the new landscape.

There is no escaping the negative impact of the pandemic on the construction industry in Latin America, both on existing projects and future potential. Each government in Latin America has taken the precautions it has deemed necessary. Some jurisdictions, like Panama, suspended all construction works with few exceptions; others, like Brazil, deemed construction works essential activities and allowed them to continue.

For all projects, nonetheless, there will have been complications: delay in obtaining materials, reduced workforce, slowdown in permits, reduced funding, insolvencies and so on, to mention just a few. Undoubtedly most projects will have suffered a delay.

Will the additional time being granted under construction all-risks (CAR) policies following an extension of time granted under the underlying construction contract constitute an aggravation of risk requiring an underwriting consideration beyond additional premium? The cost of pandemic-related delays may be unallocated and to the extent it is not prescribed in the underlying building contract, there is a concern CAR policies may respond or pass the risk on to the surety.

Surety
There is notable interest, therefore, in surety bonds, which are (usually) ancillary to the underlying construction contract and how they will respond to the ongoing pandemic. It is important to point out surety bonds in LatAm have some particular risks associated with them, which are now exacerbated. Their high risk value for one thing: historically, it would be common to see a surety bond for around 10% of the value of the works, but more recently we are seeing bonds for up to 50% of the value of projects in Latin America. Are all sureties skilled enough in construction matters to understand whether the trigger of their bond is genuine or they have become the “pandemic bank”? Can they challenge the demand? And can the surety access the huge sums of money needed at short notice to make their payment?

Most countries in Latin America have their own unique laws and regulations in addition to the terms of the surety bond itself. The reason for their concern about payment time is real: in some countries, a failure to pay can be a criminal offence. In an “on-demand” jurisdiction, there is no time (let alone opportunity) to challenge the validity of the call.

Sureties need to arm themselves with information on how the works were right before the pandemic and keep abreast of developments. A prudent surety will surround himself with an experienced professional team that can address issues timeously, is able to monitor progress and seeks to rectify concerns by commercial agreement before time expires.

In LatAm, we hear threats of a bond call simply as an additional bargaining tool where the contractor and developer are: unable to reach an agreement on changes to be made to the works; hit delays from events of force majeure; are unable to accelerate completion of the project and have run out of money; and cannot agree on who will pay for the extensions of time.

The parties therefore look to their cash-rich surety (usually outside the LatAm region), especially if they are operating in an on-demand jurisdiction. A lot hangs on how the region considers an event of force majeure and whether that defence can be carried over to the surety, as well as to the underlying contract.

Force majeure
Fortunately, there is some light at the end of the tunnel. The legal doctrines of force majeure and act of God may provide respite for concerned re/insurers acting as guarantors under these surety bonds. While each jurisdiction in Latin America interprets these doctrines in their own way, we will focus on the commonalities linking these doctrines throughout the region.

The majority of jurisdictions in Latin America define force majeure and the closely related doctrine of act of God as an unforeseen event that is impossible to resist. Most jurisdictions distinguish between the two by the type of event: if it is a natural event (such as a hurricane or earthquake) it is an act of God; if the event is man-made (such as a government order or imprisonment) it is force majeure. Interestingly, in Brazil the inverse is true; natural events are considered force majeure, while man-driven events are considered fortuitous events.

It is important to bear in mind these doctrines are legal justifications for the breach of contractual obligations; however, in most cases, these do not rescind the contractual obligations in their entirety. For example, art 956 of the Argentine Civil & Commercial Code says when the impossibility to fulfil the contractual obligation is temporary, the underlying obligation will only be extinguished in cases where time is of the essence.

We have found there are two common requirements to apply these doctrines throughout the region: inevitability and unforeseeability. In general, an event can be said to be unforeseeable when the contracting parties could not have reasonably anticipated or prevented the occurrence of the event during the execution of their obligations. As such, unforeseeability, from a legal perspective, is an event that although it may have been imagined, is sudden or unexpected and despite the diligence and care taken to avoid it, still occurred.

An event is inevitable when whomever suffers it cannot reasonably avoid its consequences. It is important to clarify it is not the event itself that needs to be inevitable, but the consequences or damages of that event that should be inevitable. We also highlight that demonstrating i) a causal link between the force majeure/act of God event and the breach of the obligation; and ii) that the force majeure/act of God event cannot be attributable to the breaching party are also common requirements seen across the region.

The legal doctrines of force majeure and act of God may provide respite for concerned re/insurers acting as guarantors under the surety bonds
Moving these concepts into the realm of surety, we point out the majority of jurisdictions in Latin America consider surety bonds ancillary to their underlying construction contracts. As such, any breach in the underlying contract excused via force majeure would also excuse breaches under the ancillary surety bond, unless the bond had provisions that say otherwise. A notable outlier to this line of jurisprudence is Colombia, which does not consider surety contracts to be ancillary to their underlying construction contracts. For this reason, it is a common practice in Colombia to include force majeure exclusions in surety contracts.

It is, however, important to undertake an analysis of the application of force majeure/act of God on an ad hoc basis. Finally, the possibility always exists the underlying parties decide not to invoke force majeure or act of God and the consequences that come from these doctrines as a defence to their contractual obligations. As such, a lot will depend on the parties’ intentions.

Generally speaking, insurance activities (including adjustments) have been considered essential activities, so adjusters have continued operating but cannot visit sites, posing complications in a region where insurers have specific time periods to respond to claims. Silence deems acceptance (Peru, for example). While orders were issued in light of Covid-19 extending time periods, we advise caution as the orders did not specifically address the laws that established these periods, therefore it would be prudent to meet them.

The insurance market in LatAm faces an undoubtedly challenging time now and in the months to come, with no real jurisprudence to follow and different regulations/positions taken in each country. How a claim will be analysed will depend on the facts of each claim set against the legal landscape in which the claim is made. Force majeure may offer some comfort where it applies. Only time will tell.

Authors: Anna Weiss, Head of Construction for Latin America and the Caribbean, Alex Guillamont, Head of Latin America and Caribbean and Javier Vijil associate in the Miami hub for Latin American and Caribbean at Kennedys.

This article was first published by Insurance Day on June 22nd 2020

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Update: Miami Latin American Claims (Re)Insurance Forum postponed until 2021

NO date Forum image jpg

In light of growing global health concerns, we have decided to postpone this year’s Forum until 2021.

The event will take place during one of the following 2021 dates which we are currently discussing with the host hotel: May 25-28; June 8-11; June 15-18. As soon as the new dates have been firmed up we will do an announcement.

We have been closely monitoring the public health situation and the health and well being of our attendants is our first priority. This is a challenging and uncertain time, it hasn’t been an easy decision, but it’s the right thing to do.

We are also planning a one day gathering in Miami as soon as the situation allows, for the market to reconvene either in person or via webcast to discuss the most salient claims, underwriting, and management topics arising from a post-CoVid Latin American and Caribbean region, ahead of the full Forum edition postponed until next year. This event will be exclusive to confirmed delegates, speakers, and sponsors.

Thank you so much for your understanding and continued support. We hope you and your families stay well and safe.

Take care and we will be back in touch soon.

Many thanks,

Alex Guillamont and Juan Lopez-Santini

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How sure is surety in Latin America?

Overhead view of construction workers and engineers at construction site

It pays to be sophisticated when it comes to surety in the construction industry in Latin America. For anyone familiar with the surety business in LATAM, especially those who have been stung, they will understand.

A surety bond is an ancillary contract to a building contract, whereby the surety guarantees to the beneficiary that the contractor will meet his obligations under the underlying building contract. They are most commonly seen in very high value construction projects, especially in publicly procured infrastructure projects, where the local authority/government would have the benefit of the bond. Historically, it would be common to see a surety bond for around 10% of the value of the works, but more recently we are seeing bonds for up to 50% of the project in Latin America. Many insurers pass over the opportunity to become a surety because the premiums are not attractive enough to justify taking on this level of exposure, they are not skilled enough in construction matters and/or they simply would not be able to access that sort of money in the short window afforded after a bond is triggered.

Most countries in Latin America have their own unique laws and regulations in addition to the terms of the surety bond itself. It is also important to know that in some countries, a failure to pay/pay on time can be a criminal offence. For example, in El Salvador, the window can be as short as 10 days for an on demand bond (i.e. where time runs from the moment the bond call is made). In an “on demand” jurisdiction, such as this, there is no time for, let alone opportunity, to challenge the validity of the justification of the trigger.

For those that venture into this world, and there are good commercial reasons for doing so, they will know that they need to keep on top of the progress of the project they are guaranteeing. A prudent surety will surround himself with an experienced professional team who can foresee issues timeously, is able to monitor progress and seek to rectify concerns by commercial agreement before time expires. Whereas in other regions, bonds are most commonly triggered when the contractor falls insolvent and thus cannot complete the works, in LATAM, this is not the picture we regularly see. Sometimes, we hear threats of a bond call simply as an additional bargaining tool where the contractor and developer are:

  • Unable to reach an agreement on changes to be made to the works.
  • Hit delays from events of force majeure.
  • Are unable to accelerate completion of the project on time and have run out of money.
  • Cannot agree on who will pay for the extensions of time.

They therefore look to their cash rich surety (usually outside of LATAM), especially if they are operating in an on demand jurisdiction. However, a skilled surety and its experienced team will act quickly and negotiate an agreed extension to the bond for an additional premium. Where bonds are conditional, the surety may challenge a call for the full amount of the bond where it does not meet the conditions. Time does not run until all conditions have been met. Therefore, it is critical to ensure that the surety team has construction expertise.

Alternatively, a surety can also step into the shoes of the contractor and complete the project. This is rare as most corporate sureties are probably not permitted to undertake construction activities. For those that can sub-contract this to another contractor, it may be a better option to do so when the project is almost complete (rather than paying over the full value of the bond which would constitute a disproportionate sum when compared with the remainder of the works).

Following the Lava Jato scandal, the largest, most skilled contractors in Latin America are often no longer legally permitted to operate in certain countries.  Consequently, completing the project on the sureties’ behalf may not be an option due to a lack of choice of local contractors with the same skills and professional capabilities to handle complex infrastructure projects of this nature.

Instead, we are seeing an influx of Asian contractors winning large, publicly procured projects such as the new metro rail in Colombia and Panama. It remains to be seen whether these contractors are prepared to step into the shoes of the local Latin American contractor half way through the works and whether the surety would want to be in that position.

Furthermore, we are commonly seeing a lack of clarity or failure to define the duration the bond following post-handover of the works and whether the full sum of the bond is reduced, commensurate with the stage of the works and post completion.

In summary and to avoid these situations, we would advise addressing these issues when the wording of the bond is being agreed and safeguarding the risk of no collateral warranty at the time of underwriting.

Author: Anna Weiss, Partner. Head of Construction for Latin America & Caribbean at Kennedys.

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