The Performance Bond in APP Contracts

Public-private partnerships (known by their Spanish acronym "APP") aim to become a new standard in public procurement and the development of public works in the country. This type of public contracting is governed by a special legal framework established under Law 93 of September 19, 2019, and regulated by Executive Decree No. 840 of December 31, 2020. Like traditional public procurement, it requires the selected contractor to provide, for the benefit of the State, a series of bonds guaranteeing the fulfillment of their obligations.

Derived from the above-mentioned legal framework is Decree No. 1-2022-LEG/FySE of April 21, 2022, which regulates bid and performance bonds for contracts under the public-private partnership regime and establishes mandatory models applicable to each type of bond.

Focusing on the performance bond, significant paradigm shifts can be observed that guarantors must consider when underwriting the risk of guaranteeing a APP project. Below is a summary of some of the most important changes, presented without a specific order:

Reinsurance Risk Rating:

For bonds issued by insurance companies that use reinsurers' backing, the Superintendence of Insurance and Reinsurance must certify that the reinsurer has an internationally recognized investment-grade risk rating issued by an agency acceptable to the Superintendence of Insurance and Reinsurance.

Right of Substitution:

Compared to performance bonds in traditional public contracting, guarantors have lost the right to substitute the contractor in their rights and obligations. As such, guarantors can no longer complete the work or fulfill the obligations of exploiting a work and take over the balance of the contract.

This right of substitution is now reserved exclusively for the APP contractor's creditors, who, under certain modalities (including the enforcement of pledged shares of the contractor's legal entity), may complete the work if financially viable. If the creditors decide not to substitute the contractor, the bond execution would proceed.

Full Payment of the Bond Amount:

As a result of the above, if creditors decide not to substitute the contractor and full bond execution is required, the guarantor will be obligated to pay the total amount of the performance bond.

Stage-based Performance Bond:

The guarantor may choose to guarantee the entire APP contract or only one or several stages. For example, a guarantor could decide to guarantee the construction phase of a project but not its economic exploitation phase. In this case, the guarantor's obligations would end upon the completion of that phase. The contractor is responsible for providing a new guarantee for the next phase.

Coverage of Penalties:

The performance bond must cover contractual penalties or other types of sanctions applied to the contractor, which may result in partial execution of payment against the bond.

Partial or Full Executions:

The APP bond regulations allow the contracting entity to execute the full bond, which, as previously mentioned, can only occur after creditors have decided not to exercise their right of substitution. Additionally, and as a novelty of the APP regulations, partial bond executions are allowed without the administrative resolution or termination of the contract.

These partial executions may occur, among other reasons, to recover expenses incurred by the contracting entity due to contractor delays, costs not covered by the renewal of insurance policies, payment of fines, and compensation for damages arising from the contractor's non-compliance.

The above is merely a summary of the main changes (though not all) introduced by the APP bond regulations regarding performance bonds. As observed, these are significant changes in the rules for contracting and providing guarantees, which in turn introduce changes in risk underwriting considerations for insurance companies during a period when the development of more projects under the public-private partnership model is expected as an alternative means of public works construction.

As of this date, there are no precedents or established criteria regarding the interpretation and application of these regulations by contracting entities, the Comptroller's Office, the Administrative Tribunal of Public Procurement, or the Third Chamber of the Supreme Court of Justice.