Perspectives for the development of performance bonds in construction contracts in Brazil

Ana Cândida de Mello Carvalho
BMA Advogados, São Paulo

Gustavo Maia
BMA Advogados, São Paulo

Rosana Hartmann Paolillo Cendon
BMA Advogados, São Paulo

Introduction

Performance bonds are undergoing a reformulation in Brazilian legislation, and are used as a surety in public and private contracts for construction and service works. Despite the possibility of obtaining performance bonds as security, performance bonds are not a developed market in Brazil, and abandonment of construction works is frequent.

There are two different types of security for performance of contractual obligations available in the Brazilian market: (1) surety bonds; and (2) bank guarantees. This article will focus on surety bonds in government contracts, especially in agreements for construction of public works.

Brazil is looking for ways to facilitate and attract investments, and the enforceability of contracts for construction works is an important factor in the country’s ability to offer legal certainty to potential investors. Performance bonds can therefore contribute to economic growth, especially considering the recent updates in the legislation and regulations and the perspectives for development of this type of security.

Performance bonds in other countries

In many countries, including both common and civil law jurisdictions, performance bonds are usually issued by banks and are an important mechanism to ensure compliance with contracts. To illustrate some of the differences and similarities, we will look briefly at one example of the use and development of performance bonds from each kind of legal system, taking as references the two largest economies, the United States and China.

Performance bonds have more than a century of history in the US, starting in 1894 with the Heard Act, which made surety bonds mandatory for all construction contracts with the government. The Act’s main goal was to transfer the risk of default to the private sector and protect workers, suppliers and the State’s interests.

In 1935 the federal Miller Act came into force, enlarging the scope and coverage of surety bonds, and including, at that point, bid bonds and labour and material bonds. Since then, almost all 50 states have enacted similar laws, requiring payment and performance bonds from contractors on state and local construction projects. Performance bonds have consequently been a contributing factor to the economic growth and development of the US.

There are similarities in the constitution and statutes of the states (most of which are common law jurisdictions), but there is no ‘national construction law’ in the US. Nevertheless, the Associated General Contractors of America and the American Bar Association Forum on Construction Law have created, and annually update, the Construction State Law Matrix as a practice guide.

By contrast, China is a civil law country and legislation is the main source of the law. In China, therefore, the concept of performance bonds is derived from the legislation and regulations governing the construction sector, including: (1) the Civil Code of the People’s Republic of China (PRC); (2) the Bidding Law of the PRC (2017 Amendment); (3) the Construction Law of the PRC (2019 Amendment); (4) the Urban and Rural Planning Law of the PRC (2019 Amendment); and (5) the Law of the PRC on Environmental Impact Assessment (2018 Amendment).

The PRC’s legislation does not, however, specifically define performance bonds. In fact, Chinese law does not restrict the types of guarantees that may be used, and a variety of guarantees can be found in construction projects, such as performance guarantees, advanced payment guarantees, and retention money guarantees.

Unlike the US, where performance bonds are mandatory for government public works and common in high-value projects in the private sector, performance bonds are not compulsory in China and the parties are free to negotiate the method, amount and submission time of the performance guarantees.

Performance bonds in Brazilian law

Since Brazil has a civil law system, performance bonds in government construction contracts are governed by legislation and regulations, especially Federal Law 14.133/2021 (Government Contracting Law) and Circular 662/2022 of the Office of the Superintendent of Private Insurance (SUSEP – Superintendência de Seguros Privados).

Unlike other countries in which performance bonds are a bank guarantee, in Brazil the most usual type of bond for construction contracts is a kind of insurance (seguro-garantia), contracted directly from an insurance company, with some peculiarities. These include: (1) the insurance contract is a tripartite transaction, involving the insurer, the construction company (as the policyholder), and the owner of the construction work (as the insured party); (2) the insurance contract covers the policyholder’s contractual obligations; (3) the policyholder pays the premium; (4) the insurance remains in effect for the term of the policy, even if premiums are not paid; (5) the insurer may request financial guarantees for payment of the premiums from the policyholder; and (6) the term of policy is related to the duration of the project.

SUSEP Circular 662/2022 defines the purpose of surety insurance (Brazil’s version of performance bonds) as a guarantee of the policyholder’s performance of contractual obligations, and specifies the main features of this type of insurance, including: (1) the distinction between the surety in the public and private sectors (in the first case, the covered contract is governed by the public law and in the second, by the private law); (2) surety insurance covers absolute risk; and (3) the policy will guarantee all the policyholder’s obligations under the relevant contract – if the insurance does not cover all obligations, the policy must clearly and objectively state which obligations are covered.

Since performance bonds in Brazil are a type of insurance, Law 10,406/2002 (the Brazilian Civil Code) also applies, because the Civil Code establishes the main rules governing insurance contracts in general. Consequently, all proposals for insurance must be in writing, as provided by the Brazilian Civil Code, and only legally authorised companies may issue insurance policies.

Changes introduced by the Government Contracting Law

The Government Contracting Law, which came into force in April 2021, updates the rules governing competitive bidding on government contracts and government procurement. The earlier legislation required security in the amount of five per cent of the original contract price, which increased to ten per cent in the case of large-scale construction works.

Among other changes, the new Law provides for security in the amount of five to ten per cent of the contract price, with the possibility of an increase of up to 30 per cent in the case of large-scale construction works and service contracts.

Another important change is the possibility that the insurance company can take over the construction works if the construction company defaults. This scenario had already been provided for in SUSEP’s regulations, but has been little used in practice in Brazil.

As its name makes clear, the Government Contracting Law does not apply to performance bonds in private construction contracts, which are governed by SUSEP Circular 662/2022 and the Brazilian Civil Code.

The main challenges for performance bonds

As we have seen in this article, the Brazilian Government Contracting Law is only part of the process of updating the law governing performance bonds in Brazil. There will be challenges to overcome, such as the technical and operational preparedness of insurance companies, and improvements in project risk analysis, credit analysis, and renewal of existing policies, especially to provide for continuation of works in the case of abandonment.

High transaction costs are also obstacles to the expansion of the performance bond market in Brazil. Nonetheless, the new Government Contracting Law will certainly contribute to the development of this type of security in Brazil and, consequently, to the growth of the economy.

Conclusion

The changes introduced by the recent Government Contracting Law presents challenges, but also offer opportunities to expand the understanding and use of performance bonds in Brazil. Moreover, the study of foreign models can help to develop improvements in this type of security, which has the potential to prevent abandonment of construction works and make government contracts more effective, which are essential to the development of Brazil’s construction law and economic growth.

Bibliography

Federal Law 14.133/2021, 1 April 2021, Law of Tenders and Administrative Contracts, https://www.planalto.gov.br/ccivil_03/_ato2019-2022/2021/lei/l14133.htm, accessed 12 March 2023.

Zheyuan Jin et al, Global Practice Guides: China Law and Practice, Chambers, 2022.

Túlio Henrique Moreira Marques, Mario Henrique Ogasavara and Frederico Araújo Turolla, ‘Surety Bond in Infrastructure in Brazil: Transaction Costs and Agency Theory Perspectives’, Revista de Administração Contemporânea v.26, 2022.

Nóbrega, Marcos and Oliveira Netto, Pedro Dias de., O seguro-garantia na nova Lei de Licitação e os problemas de seleção adversa e risco moral, Revista De Direito Administrativo, 281(1), 2022.

SUSEP Circular 662/2022, see https://www2.susep.gov.br/safe/scripts/bnweb/bnmapi.exe?router=upload/25882 accessed 12 March 2023.

Chad Therio et al, Global Practice Guides: USA Law and Practice, Chambers, 2022.

Araújo, Aldem Johnston Barbosa, Saraiva, Leonardo, Obras Públicas e Serviços de Engenharia na Nova Lei de Licitações e Contratos, Rio de Janeiro: Lumen Juris, 2021; Dabus, André. Seguros e Garantias no ambiente da Lei 14.133/21, Licitações e Contratos Administrativos.