TWENTY SECOND ANNUAL
SOUTHERN SURETY AND FIDELITY CLAIMS
CONFERENCE
New Orleans, Louisiana
APRIL 14TH & 15TH, 2011
"THE GOOD, THE BAD AND THE UGLY: THE PANAMA
CANAL AND SURETY IN INTERNATIONAL CONSTRUCTION,
THE RISKS INVOLVED."
PRESENTED BY:
PETER C. PAPPAS
FORCON INTERNATIONAL CORP.
1216 Oakfield Drive
Brandon, Florida 33511
(813) 684-7686
KATHERINE L. FREEMAN
ZURICH SURETY
“The Good, the Bad and the Ugly: The Panama Canal and Surety in International
Construction, the Risks Involved.”
2011 Southern Surety Conference
Peter C. Pappas, P.E.
and
Katherine L. Freeman, Esq., Zurich Surety
I.
INTRODUCTION
In 2007, when the author’s proposal for the expansion of the Panama Canal came in
second by a billion (that’s right, a billion) dollars, he was asked how he was going to go
back to his management, after spending over $20 million on the bid, and explain this.
He thought for a minute and replied, “How is the “winner” going to go back to his
management and explain how he left a billion dollars on the table.”
Performance and payment bonds aren’t common in foreign construction. The usual
form is a bank guarantee, somewhere in the neighborhood of 10 percent of the contract
price. However when bonding is required in foreign projects that are usually very large
the penal sums of the bonds get interesting.
In this paper we will take a recent foreign mega-project, the Panama Canal, and look at
how the proposal went together and what the risks were that the bidders faced. We will
then look in a generic way at the issues and challenges to the surety in these situations.
II. A BRIEF HISTORY OF THE PANAMA CANAL
The idea of a canal across Central America goes back to
at least 1524 but the first real attempt was made by the
French under the leadership of Ferdinand de Lesseps,
who had designed and built the Suez Canal in the 1860’s.
The Panama project kicked off in 1879 when a group of
French investors voted to go ahead. De Lesseps was
revered in France and no one thought that there could be
any risk in something built by the great man. Ground
breaking occurred in 1882. and the project was bankrupt
by 1888.
De Lesseps and his engineers made two significant mistakes in their planning . First,
they had built the Suez Canal at sea level in a dry desert along relatively flat ground
with good soil conditions but in Panama they were in mountainous jungle with very
difficult soil conditions. They insisted on a sea level canal in Panama but the task
proved to be impossible. Second, the French were not prepared for the malaria and
yellow fever that ultimately killed more than 22,000 canal workers. The project was
bankrupt by 1888 and de Lesseps and others were eventually found guilty of financial
crimes related to the project.
In 1899 Congress created a commission to look into building a canal and at first thought
seriously about Nicaragua. Eventually the U.S. bought out the French assets for $40
million and settled on Panama. However the design chosen was for a system of locks
that would raise the ships a total of 26 meters on both the Pacific and Atlantic sides,
thus eliminating the problem of trying to dig down to below sea level. The U.S. also
brought in the doctor who had been working in Cuba and who had understood the
influence of mosquitoes on tropical diseases. He instituted a program that brought the
disease problem under control.
Teddy Roosevelt, pictured left operating one of the
big shovels on the canal, was one of the main
supporters of the Panama Canal, recognizing the
economic benefits to the U.S. His actions also helped
coin the phrase “gunboat diplomacy” when he
stationed a U.S. warship off the coast of Panama to
help convince Colombia to relinquish its claim on
Panama. This allowed the new independent country
to negotiate with the U.S. and grant it complete control
over the Canal Zone.
The U.S. began construction in 1903 and completed the canal in 1914. Thereafter the
canal was operated as a non-profit facility and charged transit fees only adequate to
cover the cost of operation. After the canal was returned to the Panamanians in 1999,
they turned it into a profit making operation and it currently turns over it’s annual profit of
around $800 million to the Panamanian government. Fees for a typical large, high
value, commercial vessel are on the order of $100,000 to $200,000 for a single transit.
After the expansion is completed, the largest vessels will pay close to $1 million for a
single transit, still much less expensive than going around South America.
As an example of the impact of the canal expansion, it will allow ships carrying up to
12,500 containers to transit compared to the current limit of 5,000 containers. This has
also caused a flurry of port expansion projects in the eastern U.S. as ports gear up to be
able to handle the much larger ships that will need berthing.
III. THE TENDER FOR THE PANAMA CANAL EXPANSION
Tendering for the canal expansion was a process that went on for over two years and
kept three teams from some of the world’s largest contractors busy on a full time basis.
The team led by the author was a consortium made up of Bechtel Corp. along with
Taisei Corporation, Japans largest contractor, and Mitsubishi Corp., one of the world’s
largest trading company. Each of the partners had joint and several liability. At peak
this team had over 150 engineers and technicians working on the tender in England,
Germany, Japan, China, and the U.S.
The second consortium was made up of Sacyr of Spain, Impreglio of Italy, Jan de Nul of
the Netherlands, and several other smaller companies.
The third consortium was made up of ACS, Acciona, and FCC of Spain, Hoctief of
Germany, and ICA of Mexico.
These teams first had to go through a rigorous prequalification process that included
detailed reviews of financial and technical capabilities. This ended in late 2007 with the
teams selected.
The canal expansion was a true design-build project. The Panama Canal Authority
(ACP) had done some very preliminary design work to prove the basic concept but
otherwise the
bidders were
given
performance
criteria and were
asked to provide
their own
preliminary design
and a lump sum
price to design
and build two
complete one-mile
long sets of locks
in a rain forest
with one of the sets of locks crossing an active fault line. To understand why this would
make a good contractor cry, and to appreciate the risks that go along, it’s necessary to
understand how the canal works.
There are two sets of locks in the canal, one on the northern end and one on the
southern end. Because of the
geography of the Isthmus, the
canal actually runs from northwest
to south east.
Ships enter into the first chamber
at sea level, the gates are closed
and water enters the chamber to
lift the ship by 8 meters. The
gates open and the ship moves
into the second chamber and the
process is repeated. After rising
in the third chamber, the ship
passes through the Culebra Cut
and into Lake Gatun which is fed
by the Chagres River. The ship
then travels to the end of the lake
and enters the upper chamber of
the opposite set of locks.
All of the water used in the canal is provided by rainfall that flows from the Chagres
River and other smaller rivers and this water is used in the locks to raise and lower the
ships. The current locks, with three chambers each side measuring 110’ wide and
1,050’ long, use 26 million gallons of water for one ship transit. The three chambers in
the new locks will be over 200’ wide and 1,500’ long and would use over 70 million
gallons of water per ship transit. To avoid using this much water the concept design
called for using water saving basins, which are common in Europe, but basins of this
size had not been used before. In addition, there is an intricate system of culverts as
large as 30’ across cast into the side walls and under the chamber floors that carry
water from the lake level into and out of each chamber as the ship travels up or down
the locks. The water moves entirely by gravity. There are no pumps in the system.
Water always travels down from a higher chamber to a lower chamber even when a
ship is travelling up the system.
It was left to the bidders to do their own design of the water saving basins and the
system of culverts formed inside the 30’ thick walls, then competitively bid a lump sum
price to do final design and construction which in the end called for 4.5 million cubic
yards of concrete, 600 million pounds of rebar, and 50 million cubic yards of excavation.
At each end of each chamber there are two massive steel gates that slide sideways and
open and to allow a ship to enter the chamber, then close to let the chamber fill with or
empty depending on whether the ship is going up or down, and open to let it pass out
into the next chamber or exit the locks. Again it was left to the bidders to figure how
heavy and thick the gates had to be and how
to design the carriages under the gates so
that they can let a 3,000 ton gate travel over
200’ with more than 99% availability. Since
there are two gates at each end of each
chamber on both sets of locks, there are a
total of 16 gates and no two pairs are
identical.
The canal is a very profitable business for the
government of Panama, and the Panama
Canal Authority turns over roughly $800
million per year to the government.
Therefore the specs imposed a very exacting
requirement for the transit time for each ship going through the canal so that at least 18
ships could transit each day. And to make sure the contractor kept this at the front of
his mind the specs provided a set of acceptance testing to be done after the locks were
finished. This included maximum transit time through the locks, travelling speed of the
gates, and emptying and filling times for water in the chambers. At first, the penalty for
failing this acceptance test was that the contractor had to return all the money they were
paid to design and build the locks and demolish what they had built. Cooler heads
prevailed and after much negotiation the canal authority agreed that the contractor, on
failing the tests, only had to return a few hundred million dollars not counting LD’s.
IV. BONDING THE PANAMA CANAL EXPANSION
The Panama Canal Authority decided early in the game that it wanted performance and
payment bonds on the project and not the typical 10% bank guarantee that is normally
seen on foreign jobs. The original RFQ asked for 100% performance and payment
bonds. Everyone knew that this project was worth several billion dollars and there was
considerable concern among the Spanish, Italian, French and other European bidders
who do not normally need bonding and who, in some cases, were far too weak to be
able to obtain these bonds. This touched off considerable inside political maneuvering
by the foreign competitors and over the course of the next several amendments to the
RFQ (there were ultimately more than 20 amendments) the size of the penal sum of the
performance bond was lowered to $400 million and the payment bond was lowered to
$50 million.
V. KEY RISKS FOR THE COMPETING CONSORTIA
In the Bechtel/Taisei/Mitsubishi consortium, just as in the others, there was a focus on
evaluating and mitigating risks. The risk register for this bid had several hundred risks
identified and mitigation actions were identified for each as well as probabilities of
occurrence. Before a proposal could be submitted senior management for all three
companies had to be satisfied that all risks had been identified, analyzed, and mitigated.
For the purposes of this discussion ten major risks that can affect a very large scale
international project like this have been identified. We will consider how the contractor
looks at those risks here and discuss the Surety’s perspective next.
1. Escalation risk. The contractor will be buying nearly two billion dollars of
materials and over three hundred million dollars of heavy equipment over
a five year period. Much of it could be contracted for early but first the
contractor has to go through a one year design process to understand
what materials and quantities are required. He knows that steel suppliers
and cement suppliers and others will not guarantee their prices for more
than a few months. Companies like Bechtel have large and sophisticated
purchasing organizations that track and forecast material and commodity
price moves but they know that prices for most commodities can double or
halve in a year. How can a contractor set his lump sum price with these
uncertainties?
2. Schedule risk. At the point of submitting the proposal the bidders for the
canal had no detailed design and no fixed quantities, and in fact still had to
schedule a year of design work before material could be bought and the
first cubic yard of the 4,500,000 cubic yards of concrete could be placed.
He then had to take an educated guess on how difficult the 50 million
cubic yards of rock would be to excavate and how long it would take to
crush this rock into sand and gravel that could be used in the concrete
mix, since there was no rock or sand around. He then had to count on
Caterpillar being able to deliver sixty 100 ton trucks on time, at a point
when Cat’s delivery lead time on these mining trucks was 18 months, so
he could haul the 50 million yards of rock. He had to hope the weather
would behave and the rainy season wouldn’t be too severe so that his 60
trucks wouldn’t sink out of sight. He had to count on the sixteen gates that
are 200 feet long and 100 feet high and 30 feet thick and that weigh 3000
tons each not sinking when they were completely assembled in China and
set on a semi-submersible ship in the Yangtze River and sailed to
Panama. If the contractor doesn’t get all this right, the LD’s are over
$300,000 per day not counting the extended overhead for 7,000 people. It
takes an outstanding management group and the world’s best technicians
to get this right. How does the Surety get comfortable here?
3. Design risk. Over 200 designers from at least five different companies
working in at least 6 different countries on three continents have to
coordinate their work and produce several thousand drawings for a oneof-a-kind facility in less than a year. And this design has to be controlled
so that it can be built for less that the lump sum price so estimators have
to be part of the design team and run estimates constantly as the design
develops. Controlling this process takes experienced design management
that has done it before as well as state-of-the-art IT technology that can
move megabites of data between countries seamlessly.
4. Quantity risk. The conceptual design provided by the canal authority was
no more than outlines of what the locks could look like so there were no
quantities available to the bidders. It was necessary during the bidding
phase to complete enough design to understand basic quantities such as,
how thick the walls are (over 30’ in some areas), or how much rebar is
needed, or how deep the excavations have to go. The contractor then has
to hope that his design team can produce a final design within the
boundaries of the bid team design. In design-build work design creep is a
real and serious risk that a contractor has to control or costs spiral out of
control. Bechtel management uses the term AFGIS to remind their bid
teams to consider the Allowance for Growth in Scope when deciding the
final quantities to price.
5. Currency risk. When working in a foreign country U.S. contractors will
normally insist on being paid in U.S. dollars but often the foreign customer
will not accept this. The U.S. contractor also has to pay expenses in
country in the local currency and often has to buy materials in third
countries in several other currencies. No matter how sophisticated the
contractor is in working in foreign situations, the recent history of
fluctuations in the U.S. dollar compared to the Euro, the Pound, and
several other currencies proves the point that sharp and unpredictable
moves can take a big bite out of profits.
6. Political risk. If a contractor is planning to work in London or Japan there
is little in the way of political risk. In other countries in Latin America,
Africa, and Asia there are multiple political risks that can spell disaster for
the contractor. It could be something straight forward like a sudden
increase in local taxes or a coup with a new government that decides it
has to review all of the “corrupt” contracts that the former government
entered into. On the Panama Canal bid, the Bechtel/Taisei/Mitsubishi
team made full use of the leverage that the U.S. and Japanese
governments could apply in Panama. Numerous meetings were held with
the U.S. and Japanese ambassadors to Panama and their staffs. They in
turn, along with their counterparts in Washington and Tokyo, did what they
cold to influence the Panamanian government. Wikileaks published at
least six cables from the U.S. ambassador in Panama to the Departments
of State, Commerce, Treasury, and Transportation as well as the CIA and
other embassies.
7. Acceptance testing risk. The seriousness of this risk is specific to a
project but it can be a very real risk when the customer is a foreign entity,
including a foreign government. In countries with weak legal systems the
customer can arbitrarily reject testing and use the rejection as an excuse
for applying LD’s or delaying payments or forcing the contractor to accept
price reductions. How can the Surety evaluate this?
8. Logistics and customs risk. Large foreign contracts by their nature mean
that the contractor will have to ship large quantities of critical materials and
equipment long distances on very tight schedules. And when the material
arrives in country the contractor still has to clear it through customs, and
customs may not always be cooperative and honest. The author has
experience in situations where customs has held materials for months
before finally clearing it after suitable payments were made. Can the
Surety do anything to protect itself in this situation?
We have so far discussed a large, high profile international project that included some
of the largest contractors and engineers in the world and involved multiple significant
risks to the contractor. However there are also smaller and less complex foreign jobs
that require performance and payment bonds and many, if not all, of the same problems
and risks apply. We will now look at some of the legal risks that the surety faces in the
international market.
VI. AN OVERVIEW OF INTERNATIONAL SURETY – LEGAL AND UNDERWRITING
International contract surety includes a wide variety of project types and scopes. Some
projects, such as the Panama Canal, are huge, incredibly sophisticated undertakings. Other
projects that sureties may write may be technically similar to work bonded in the North American
market. However, even on those apparently more “typical” projects, international work imposes
another layer of risk analysis and complexity for the surety.
The most important thing to remember is that international surety projects are not simply North
American projects “transplanted” to another location. The contract scopes and structures may
be different. The organization of the principal/ contractor and of the obligee may be much
different and more complex than typically seen in North America. The distinction between
“public” and “private” work may be much grayer, because many countries have governmental
entities which support or guarantee private companies or which contract private projects. The
bond forms may contain terms unique to the jurisdiction, or may not contain terms that we are
accustomed to seeing. The surety’s rights and remedies may be dramatically different and
more limited, and the role and rights of a project lender or financing organization may be equal
to, if not superior to, the surety. Indemnity rights may be extremely limited and costly to pursue.
Judgments may be difficult to enforce in another country. Therefore, international surety bonds
require careful consideration of their unique features in order to properly evaluate and
underwrite the risk.
Contract development
International contracts may have a wide scope of variation. Mammoth international contracts
are likely to have extremely detailed and well-developed terms which are negotiated between
the parties. At the other end of the spectrum, some international contracts may be much less
defined than contracts we are usually accustomed to seeing. The relationships may be much
looser, and some arrangements may be memorialized by a short letter and then “working it out”
as the project goes along. Courts may look much more at the “intent of the parties” to fill in
gaps, and may disregard or rewrite terms or concepts that are deemed unacceptable in the
jurisdiction.
The contract review and negotiation process may cross language, cultural and political barriers.
For instance, some concepts, such as the contractor’s assignment of rights to the surety, may
be virtually unknown and undeveloped in the local law. Others, such as “indemnity” or “penal
sum” may be known by other names or those terms may mean something totally different in that
country’s language and industry. The surety should become involved as early on as possible so
that critical issues can be identified and addressed.
International Surety Bonds
a. Performance Bonds
International projects may have something called a Performance Bond. A surety should not
assume that an international “Performance” Bond is similar to what we envision as a
Performance Bond here in North America. There are no standard “international” forms, and the
customary forms may vary widely from country to country. Some larger projects may accept
standard U.S. Bond forms, such as AIA forms or ConsensusDocs forms. However, most forms
will be unique to the jurisdiction (and are unlikely to be in English, a further complication).
International performance bonds tend to be shorter and more general. They often lack familiar
terms, or may contain terms uncommon to the North American market. For instance, there may
not be any notice requirement for default and termination until the owner makes a claim, after
the project is complete. A formal termination may not be required to recover under the bond.
The owner may have a wide variety of self-help available, and the surety may have very limited
influence on the direction taken by the owner after a default occurs. Also in many cases, the
surety has more limited remedies after default, particularly for on-demand Performance Bonds
discussed below.
The bond penal sum may be a percentage of the contract price, rather than 100%. The lower
penal sum seems a favorable risk development, and in many cases it is. However, a
percentage penal sum also makes it more likely that a surety would incur a full penal sum loss if
a claim materializes. The smaller penal sum also might make the surety a “bit” player in the
dispute, with very little leverage or control over the process. Further, the contractor still is bound
to the owner for all damages awardable under its contract, and the contractor therefore could
incur a significant financial loss if put into default. This loss could place the contractor’s other
work in jeopardy and lead to surety losses on other bonded projects.
b. On-Demand Bonds
One common type of Performance Bond in the international market is an On-Demand
Performance Bond. These bonds act as financial security, similar to an Irrevocable Letter of
Credit. Typically, in markets where On-Demand Bonds are prevalent, sureties compete directly
against banks for securing a construction project – sureties by issuing on-demand bonds and
banks by issuing Irrevocable Letters of Credit (ILOCs).
As a result, bond terms also tend to be very brief and may limit the surety’s obligation to
payment of money. This payment may be a pre-established penalty rather than an amount
related to the obligee’s actual damages arising from the default.
On-Demand Bonds may be “unconditional,” meaning that the obligee’s claim is comprised
merely of a demand letter. The surety’s only defense is the form of notice, and even that
defense may not be allowed under certain bond forms. Some bond forms expressly require the
surety to pay over the principal’s objection and despite the principal’s defenses to the claim.
Other On-Demand Bonds are “conditional,” meaning that the obligee’s claim must be
accompanied by certain documentation or proof of breach, a notice of default, or some other
evidence beyond a bare demand. The surety may assert defenses to the claim, although the
defenses are likely much more limited than with a typical Performance Bond.
c. Payment Bonds
Payment bonds are rooted in lien law developed from the common law tradition. Many
countries with different legal systems do not have similar mechanic’s lien concepts, and so do
not typically require Payment Bonds. However, as international projects grown in scope and
size, North American surety law concepts regarding payment bonds have occasionally been
adopted. Payment Bonds will probably become more common in the international market as
contract surety becomes more global.
d. Indemnity Ramifications
One critical legal concept dealing with international surety is the potential impact on the surety’s
indemnity rights if the contractor or its parent company are located outside North America.
North American style indemnity agreements are very different from those used in other
countries. Many indemnity concepts do not transfer well from one legal system to another. It
can be challenging to develop and negotiate an appropriate indemnity agreement which
provides the surety with the security it needs while also being enforceable and acceptable in the
international jurisdiction.
To the extent that any “typical” indemnity agreement exists, the type and complexity will vary
widely. A wide range exists, from a one-page very basic “indemnity” to a much more sizeable
“deed of indemnity” which may contain terms somewhat similar to a loan agreement. True
“industry standards” for indemnity are rare. Further, even if an indemnity document is common
to the particular jurisdiction for local projects performed by local companies, the document may
not give a surety the tools and provisions it needs to protect itself in the more complex
international contract surety arena.
Here are some typical indemnity provisions which may create concerns for international
customers or their sureties:
Exoneration/ Place in Funds: Some countries have a well-established concept of exoneration or
placing the surety in funds, but other countries may not. As a result, international companies
struggle with the idea of being required to post funds with the surety before a “debt” is fully
established. Generally, a surety lawyer can educate the customer on the reasons for
exoneration and help the customer better understand the requirements of an indemnity
agreement.
Limitation on amount or time: Many countries may require that an indemnity agreement and/or
parental guarantee have some sort of limitation in order to be enforceable in that jurisdiction.
For instance, the indemnity agreement may have to state a specific dollar value at which the
indemnity obligation is capped. Other countries do not require a cap, but require a specific time
limitation be stated in the agreement.
Pari-passu and Assignment: In Europe and many other countries, sureties are viewed as
substitute bankers of sorts. In those countries, creditors may be required to share in any
recovery “pari-passu.” This means creditors get an equal split of any recovery (similar to a very
simplistic bankruptcy here in the US, with all creditors in a single class). Unfortunately, paripassu has significant ramifications on two of the surety’s most valuable assets: contract
balances and assignment rights. First, a surety should understand what qualifies as “assets” in
the applicable country. Many countries view contract balances as an “asset” of the principal
which must be divided among creditors, because the applicable surety law does not generally
envision true performance obligations. However, as projects grow larger and more complex,
obligees may require a performance bond which requires some degree of completion obligation.
Under a worst-case scenario, the surety could find itself obligated to bear the entire cost to
complete the project, but having to share contract balances with other creditors on a share and
share alike basis. Further, a number of countries view any assignment language in the GIA or a
parental guarantee as a breach of this pari-passu equality of creditors. Rights or assets cannot
be assigned to one creditor (the surety) to the detriment of the other creditors. Therefore, a
surety’s assignment rights may be curtailed or voided entirely. A surety attorney should be very
careful to understand the applicable law in the country where the contract occurs, and in the
country or countries in which the surety may need to exercise its indemnity rights, as well as the
implications on bond and contract language and indemnity rights.
Enforcement: One significant challenge in any international project or indemnity action is
enforcement of the surety’s rights and remedies. A surety writing a bond or taking indemnity in
a particular jurisdiction should understand the legal system and differences in contract, bond
and indemnity application and interpretation. Otherwise, a surety may find itself faced with
unexpected obligations and huge obstacles to enforcing its rights, or even in enforcing and
collecting under a judgment against the obligee or its indemnitors.
There are a number of legal resources available on the internet, as discussed below. These
resources can be very helpful in understanding the political, cultural and legal environment in
which you are working. However, local counsel who is knowledgeable in surety law, assuming
such can be found, is strongly recommended. Local counsel can guide a North American surety
attorney through the process and to draft or at least comment on the agreements pertinent to
the contract, bond and indemnity, and assist in addressing these legal challenges.
VII.
LEGAL AND RISK MANAGEMENT CHALLENGES IN INTERNATIONAL SURETY
As the Panama Canal project and the above discussion indicates, International Surety poses a
number of unique legal and risk management challenges for the surety. First, a surety attorney
has to understand and properly identify the risks that need to be addressed. In order to identify
those risks, the attorney must understand the differences between North American contract and
surety law and that in the foreign jurisdiction, and then develop a means to contain, control and
resolve them.
For instance, the surety attorney must identify when the surety’s obligations begin. This may
not be clearly defined in the bond, or may not relate to a clear default by the principal. Many
jurisdictions do not recognize the concept of “termination” and may look to the surety to cure
any breach or default, or simply to pay money when it is demanded. Closely examine the bond
language and the terms of breach in the particular contract. Negotiate appropriate default
terms and tie those to the surety’s obligation if that can be achieved.
Also, closely examine whether and to what degree the surety can assert the defenses of its
principal. It is not unusual to see requirements in international bonds which require the surety to
act over its principal’s objection. In many countries, this plays out (as a practical matter) as a
payment with a reservation of rights. The surety pays or performs, and the principal then
litigates against the obligee to recover the cost if the obligee’s claim was wrongful.
A surety attorney also should confirm whether the surety has any ability to assert any
independent surety defenses. In many countries, these defenses may be extremely limited or
may not be recognized at all.
A surety attorney should discuss the applicable indemnity issues with its indemnitors and
confirm that its indemnitors understand the risks and their unconditional obligation to make the
surety whole, regardless of any defenses which the surety or the principal might have. A surety
attorney also should include appropriate place in funds language (with a very short trigger), right
of settlement, waiver of principal and indemnitor defenses against the surety, and other similar
provisions as the surety deems fit, in its indemnity agreements and parental guarantees. A
surety attorney should also make sure its indemnitors understand that their liability to the surety
is joint and several, if that is the surety’s intent, particularly if a guarantor is involved. Many
guarantors will expect the surety first to seek recovery against the principal or the front-line
indemnitors first before the surety can make demand against the guarantor. In these instances,
it is critical to negotiate clear and very limited timeframes and conditions before the guarantor is
required to make the surety whole.
These contract and indemnity challenges may become even more complex if multiple
jurisdictions and venues are involved. For instance, a contractor may be from the United
States, its parent company and indemnitor may be in Europe or Asia, and the project may be in
Latin America. Further, the assets may be in several other countries. This level of complexity is
becoming more and more commonplace, and it is even more essential to investigate and
understand how the various legal issues and concepts will “flow” through the multiple locations,
and the path through which a surety would be required to pursue indemnity, enforcement and
recovery.
There may be some jurisdictions in which enforcement and recovery could be difficult, if not
impossible. For instance, court systems may be completely unpredictable, unfriendly to North
American companies, and disputes could drag out for years. Surety law may be virtually nonexistent and therefore after-the-fact enforcement and recovery unlikely. In these instances, a
surety would need to determine whether it is still willing to write the particular risk, and should
make alternate arrangements for its protection. This is where local counsel can be invaluable in
giving accurate information regarding the difficulties in the particular country so that the risk can
be properly underwritten. Indemnity options such as taking collateral up front, obtaining multiple
indemnitors (including indemnitors in the US or another “friendly” venue) and strong and quick
place in funds language could serve as options for difficult risks.
On the other hand, a number of jurisdictions have very strong legal systems and well-developed
surety law. While the legal concepts and court systems may be structured differently from the
US, these jurisdictions may be appropriate and profitable locations for surety work. Also,
arbitration is often a very viable option, even if the courts are not. Investigate the resources and
determine what provisions would work for a particular situation.
It is also recommended to have all documents state that they are to be written and interpreted in
a stated language, such as the English language, and that any litigation, mediation or arbitration
will be conducted in that language. Further, even the most basic bond and contract terms
should be clearly defined. Some countries use different terms, or even conflicting terms,
compared to North American surety law. An obligee in one jurisdiction may be known as the
“principal” or the “beneficiary” in another. “Indemnity” may be known as “reimbursement” or a
“guaranty.” Even more confusing, some standard North American terms may have a completely
different meaning in another country. For instance, in the United States, “penal sum” or “bond
penalty” is defined as the amount of the bond. However, in many countries, these terms refer to
a true and fixed penalty assessed if the contractor breaches the contract. It is critical to define
the terms, based on the applicable law and usage, so that the documents can be correctly
drafted and interpreted.
Also, execution of documents will likely follow different procedures than in North America. For
instance, notaries may or may not exist in the country. Documents may need to be apostilled or
otherwise certified by a governmental agency, in order to verify the signatures. The country
may have a corporation code under which the document can be sealed rather than signed, or
requiring only specific authorized and registered persons to sign the document in order for it to
be enforceable. A surety attorney should confirm the legal requirements for execution, and may
need to consider having a local attorney review the executed documents, particularly any
indemnity agreements or guarantees, and provide a legal opinion that the documents were
properly executed.
In addition to contract and indemnity issues, a surety will need to examine co-surety and/or
reinsurance requirements. Many large projects will require co-sureties, and that relationship will
have implications on the contract and indemnity issues. In addition, many North American
sureties are not licensed to write bonds directly in a number of foreign countries. Therefore, the
North American company will need a “fronting” surety who will issue the bonds on their behalf,
with the North American company serving as a “reinsurer” to the fronting surety. Usually this
fronting surety will require its own indemnity agreement with the principal and indemnitors
(sometimes putting the fronting surety in a superior position to the reinsuring surety). The
fronting surety can often guide the reinsuring surety on licensure issues and compliance with
local laws, but generally independent counsel is recommended.
The surety should understand the interaction between foreign insurance law and financial
regulations in the country. As stated above, in many countries, sureties and lenders are
relatively direct competitors in offering security for construction projects. The particular country
may treat a bond much more like an Irrevocable Letter of Credit, and therefore treat a surety
much more like a lender. It may be important to understand the country’s applicable financial
regulations and to confirm that those regulations do not conflict with a surety’s internal policies
or domestic regulatory requirements. Also, many countries have strict privacy laws which may
complicate or conflict with a company’s normal document handling and retention standards.
Again, a surety attorney should consider these issues in any risk management evaluation.
It is important to know where to start your international legal research. The internet is a good
starting point, and there are a number of free resources for international legal research. The
following sites are good places for basic information:
For legal, cultural and political research:
Globalex, NYU’s Foreign Law Research tool http://www.nyulawglobal.org/globalex/Foreign_Law_Research1.htm
World Legal Information Institute - http://www.worldlii.org/
Juriglobe, University of Ottowa Foreign Law database - http://www.juriglobe.ca/eng/index.php
Washburn University School of Law, by country and/or region http://www.washlaw.edu/forint/alpha/n/northamerica.html
Federal Judicial Center, Primer on the Civil Law System http://www.fjc.gov/public/pdf.nsf/lookup/CivilLaw.pdf/$file/CivilLaw.pdf
Library of Congress, Guide to International Law Online http://www.loc.gov/law/help/guide/international.php
Library of Congress, Global Legal Information Network - http://www.glin.gov/search.action
The World Bank Group, Doing Business Law Library - http://www.doingbusiness.org/law-library
InterNet Bankruptcy Library, International Bankruptcy and Insolvency Laws http://bankrupt.com/lbr/internationalbankruptcyrules.html
Society of Construction Law, mostly UK but may have broader applicability http://www.scl.org.uk/papers
The Economist - http://www.economist.com/countries
For law firms working in various countries:
Consulegis - http://www.consulegis.com/
Lexmundi - http://www.lexmundi.com/lexmundi/default.asp
International Bar Association - http://www.ibanet.org/Default.aspx
The Legal 500 - http://www.legal500.com/
Lastly, a surety should understand the implications of cultural, language and political issues on
legal analysis. Cultural and political factors can enhance an already strong relationship, or
conversely can derail the project completely. Language barriers and conflicting usage or
definitions of seemingly identical terms can create miscommunications which could disrupt even
the most strongly worded contracts. All of these issues can be managed and mitigated with
proper research and planning during the underwriting process.
VIII.
CLAIMS CHALLENGES IN INTERNATIONAL SURETY
Claims challenges also should be anticipated and investigated during the underwriting process.
A surety attorney should understand whether a claims handler must be licensed in the
jurisdiction, and what requirements might be applicable. A number of countries and territories
require that claims handlers be located in-country and have specific licensure requirements.
This is an expense and condition that should be anticipated up front. Further, the investigation
process may be affected. Bonds with simple terms and few defenses available may only
require review of the notice and limited documentation. On the other hand, bonds related to
large, complex projects with multiple parties may require a team of specialists and investigators.
Again, these needs should be anticipated up front, so that a surety is prepared to respond
promptly if a claim arises.
Notice of a claim: The bond terms and/or local law and practice will dictate notice requirements.
Frequently the requirements are incredibly brief. Usually, notice will be served on an in-country
agent or underwriter. The bond should indicate an address for notice, if possible. The surety
then should put in place a process for the notice to be received and transmitted to the claims
handler in a timely fashion. Notice will likely be given in the country’s language, which means it
must be translated. If supporting documents are desired, the surety should be prepared to ask
for them quickly, as timeframes for response to claims are usually very short.
Performance Bond issues: As stated above, many international bonds do not envision formal
completion by a surety. The performance requirement may be payment of a set sum, or
reimbursement of the obligee’s damages. Often investigation time is very limited, and defenses
are even more limited. A surety attorney should understand what procedures are required to
respond to a performance claim, and confirm the legal requirements and ramifications, so that
the surety can respond appropriately.
If formal completion is an option under the bond, this completion will likely raise a number of
additional issues compared to a North American project. Local consultants, or at least
knowledgeable consultants with international experience, will probably be required. Most of the
documentation will not be in English and will require translation. There are likely to be a number
of entities involved, including governmental entities, even on private projects. Therefore, a
surety may find itself dealing with a wide group of people, all having some input into what will be
required from the surety. You may also find that negotiation becomes a much more critical
process, and that give and take is expected in order to resolve any dispute. Finding the proper
balance between social and business expectations and legal obligations may be a delicate and
challenging task.
Even physically making the payment can be challenging. Information must be collected, verified
and transmitted prior to payment. In the case of a United States surety, Federal law, such as
The Patriot Act, may impose regulatory requirements and oversight of any payments made. If
the payment is to be made internationally, wire transfers may be used, particularly if the
country’s banking system is unstable or limited. Also, determining the proper currency for
payment may be an issue, and may affect the timing and method of payment.
Payment Bond issues: Payment Bonds are not as common in the international market as
Performance Bonds. However, when a Payment Bond is issued, it may create unexpected
challenges. Notice and language barriers may be significant. Documentation may be difficult to
understand or non-existent. Many countries may not have common procedures for periodic
payments and releases. In fact, in certain countries, payment of subcontractors and suppliers is
typically made in cash. Therefore, merely determining the contract amount and current contract
balance may be an effort. Physically making any required payment may be another effort, as
discussed above. However, these issues can usually be resolved with proper research and
local assistance.
Exoneration and Indemnity issues: A surety should consider exoneration and indemnity issues
as part of the underwriting process. However, even the best plans may prove difficult to
execute if a dispute arises. Receiving adequate collateral up front places the surety in a much
stronger position, and should be carefully considered, particularly for international customers.
Strong indemnity agreements, appropriately drafted for the applicable jurisdictions, timely and
detailed periodic financial reporting, and close oversight of the account and the project are
critical.
If a dispute with your indemnitors arises, local counsel will likely be required to guide you
through the resolution process. That process may include litigation or arbitration. A surety
attorney should understand the laws applicable in the jurisdiction for litigation, arbitration and for
enforcement of judgments. These may include legal sources not commonly considered in the
domestic market, such as international treaties:
Arbitration Treaties:
The United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards
(the “New York Convention”), 1958.
http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/NYConvention.html
The Inter-American Convention on International Commercial Arbitration, 1975.
http://www.adr.org/sp.asp?id=31620
Enforcement of Judgments:
Hague Convention #16: Convention of 1 February 1971 on the Recognition and Enforcement of
Foreign Judgments in Civil and Commercial Matters, entered into force 20-VIII-1979 (only five
countries have actually ratified this treaty as of late 2010 – the US is not one of the ratifying
countries. However, the principles embodied in this Hague treaty are a good starting point for
seeking to enforce a US judgment in any foreign country).
http://www.hcch.net/index_en.php?act=conventions.text&cid=78
Related Treaties:
Hague Convention #12: Convention of 5 October 1961 Abolishing the Requirement of
Legalisation for Foreign Public Documents, entered into force 1965; (a very large number of
countries have ratified this treaty, including the United States).
http://www.hcch.net/index_en.php?act=conventions.text&cid=41
Hague Convention #37: Convention of 30 June 2005 on Choice of Court Agreements, not yet
entered into force. The US, Mexico and the European Union have ratified this Convention, and
so it would serve as guidance for any venue provisions in International contracts, at least with
respect to these countries, even though the Convention itself is not yet effective.
http://www.hcch.net/index_en.php?act=conventions.text&cid=98
As the construction market becomes more global, international surety provides exciting and
challenging opportunities for North American sureties. The applicable laws and the cultural,
political and financial issues will often direct, or at least strongly influence, a surety’s course of
action, and the eventual outcome of a claim. Sureties can use all these issues as tools to
evaluate the risks and challenges and lay the foundation for a successful and profitable venture
into this global market.