JUDICIAL  BOND

High level definition of a Judicial Bond

 

  • A Judicial bond is a bond required by the courts, in order to secure a party’s costs of appeal, attachment, and injunction. A bond is filed with the court as a guarantee.

  • Judicial bond includes specialized bonds such as fiduciary bond, removal bond and appeal bond.

  • Surety deposited by a party to a lawsuit to indemnify the opposing judicial or governmental body party from any loss arising from delay or depravation caused by the legal proceedings. In general, all bonds required in judicial proceedings are called judicial bonds.

 

 

 

 

  • Types of Judicial Bonds                                                 

 

- Judicial Bonds can be divided into two categories:

  1. Defendant Bonds

  2. Plaintiff Bonds

  • Defendant bonds block a plaintiff’s action or postpone payment of a judgement. They generally permit the defendant to regain control of contest property or postpone the enforcement of a decree affecting rights to property. Common types of defendant bonds are Bail bonds, Appeal bonds, Counter- Replevin bonds, and Release of Lien bonds.

 

  • Plaintiff bonds are required of plaintiffs to ensure protection of the defendant should the plaintiff lose the lawsuit. They hold the plaintiff liable for any damages that the defendant suffers due to the result of the court proceeding. Common types of plaintiff bonds are Attachment bonds, Claim and Delivery bonds, Indemnity to Sheriff bonds, Injunction bonds, and Replevin bonds.

 

 

How did Judicial Bonds emerge in the Brazilian Surety Market

 

  • In Brazil judges require the defendant party in a judicial dispute to provide collateral as a form of guaranteeing their ability to pay potential indemnifications. Historically, courts/judges would accept cash, government bonds, other assets (at their own discretion) and bank guarantees or LCs.

  • The surety bond product was already available under the former SUSEP norm called "Circular SUSEP nº 232, year 2003", but the product did not find acceptance by the Brazilian courts, because there was no law admitting it.

  • In addition, the product was not effective and thus not accepted by judges, because it did not cover the whole judicial litigation (the surety had the right to refuse the renewal of a bond).

  • In 2006 a reform of legal procedures was passed in Brazil and according to one of the revised articles, surety bonds became accepted as a new form of collateral in civil litigation. Hence, the code of civil litigation placed courts/judges in  a position to accept judicial bonds (as a surety product) in civil-law disputes.

  • Up and till 2009 the acceptance of surety bonds by courts/judges remained very limited, with total premium issued per year not even reaching BRL 100m. Over the following 5 years though, the insurance product acceptance grew steadily yoy due to a variety of decrees and guidelines from SUSEP and the National Insurance Federation helping regulate policy terms and conditions. From 2014 onwards the surety industry’s steady lobbying activity and the acceptance of Judicial Bonds by PGFN (Procuradoria General da Fazenda Nacional) provided initial spark for a wider spread use of   this bond type. Yearly premium rose to BRL 800m to then grow to more than BRL 1bn by now.

 

 

 

For which judicial processes is it mainly used in Brazil?

 

 

  • Traditionally, one distinguishes between 3 categories:

  • Tax (80%): circulation of goods, income tax, social contributions, service tax, amongst others (Complex Tax Systems drives demand for bonds)

  • Civil (14%): regulatory disputes, fines and penalties; Litigation between parties.

  • Labor (6%): labor disputes between employer and employee.

  • Specifically for taxes, Art. 9 of law 6.830, was amended by the Insurance market and “Fiança Bancaria ou Seguro Garantia” was added as a substitute to the already existing products to guarantee a tax process

  • The product can be used whenever a client needs to provide security for a lawsuit such as in tax matters. For the taxpayer to challenge a tax bill before the courts, a security in the form of a Judicial Bond must be posted beforehand.

 

 

This also leads to diversification in the risk landscape/composition of risk portfolios

 

 

  • Industries which traditionally have not formed part of a surety risk landscape can now be tapped, diversifying the risks away from construction and engineering into other, unrelated industries.

  • Example of a surety portfolio by industries (in total 25 different industry sectors):

  • Typical Distribution in terms of overall exposures can be (in one example):

    • 27% Financial Sector (mostly Banks)

 

  • 10% Oil & Gas

 

  • 9% Food

 

  • 8% Pulp and Paper

 

  • 7% Beverage, 7% Steel

 

  • 6% Retail, 6% Telecom, 6% Consumer Goods

 

  • 4% Pharmaceuticals.

 

Offering substitute banking products - leads to diversification in the risk landscape/composition of sureties’ portfolios

 

 

  • Insurers get access to industries and clients which otherwise do (often) not need any bond or are serviced by banks alternatively.

 

  • Positive diversification effects due to wider risk distribution by industries and names (obligors).

 

  • Corporates in need of a judicial bond are not necessarily the surety’s usual clients but can be ‘new’ names to the industry

 

  • Claims activity is not correlated with economic or industry cycles.

 

 

Difficulties of the product and Challenges

 

  • bonds have characteristics of financial guarantees: abstract, unconditional, on demand, absence of right of objection and defence

  • indefinite tenor (the weighted average of bond tenors is around 4 years, however, in theory the tenor is open ended, as the underlying bond has to be prolonged, as long as no definite court decision is being taken = ‘forced’ policy renewals)

  • matter in dispute is often hard to assess as to its outcome (often complex cases) and furthermore impacted by “human factor”, as judges can have different views on one and the same issue – limited predictability

  • if insured amounts are high, policyholders often get discounted rates (and insured amounts are often very high in Brazil, the largest one I saw was in the range of BRL 4bn)

  • risk selection against insurer - banks may be tempted to shift risks to the insurance market, if they themselves do not feel sufficiently comfortable or have reached risk aggregations of critical size

  • small risk population and often larger sums insured together with low EDF (Expected Default Frequency) imply high volatility of business; severity risk is prominent but  mitigated by stringent risk selection.

 

 

Underwriting / Underwriting Criteria

 

  • Obligor: financial profile and ability to pay debt in dispute (liquidity) are key point of analytical work and risk assessment.

  • In our view, this product is only suited for top tier companies.

  • Merits of the matter in dispute: the strength of the obligor’s case / legal precedents

  • Security instruments, strengthened counterguarantee texts with place in funds clauses or even collateral/real counterguarantees

  • Tenor and complexity of the underlying dispute

  • Premium rates - needs to be risk adequate (which is often not the case, above all if pricing is compared with the bank guarantee pricing)

 

 

 

Claims Experience in Brazil

 

 

  • There´s no evidence of any larger claims in Judicial Bonds.

  • One case is known to the market in which the sum insured was in the range of USD 4m. The loss concerns a mid size company in the mining industry which had lost a civil trial on a sales contract. However, a recovery scheme is in place: the company which defaulted under the bond has committed to a repayment plan (the fact that the surety insurance company paid the claim maintains the good image for the product).

  • Maybe this case shows that the Judicial Bond product should only be used for top tier companies, mainly large globally active companies, and therefore we now see names that are new to the surety  industry.

 

 

Claims Experience

 

  • Otherwise claims experience is very good. Since this product became so needed by the clients, the market understands that the likelihood of one client letting a judicial bond go into default is small. It would only happen if the company has no other solution to present. That´s why structuring a portfolio with several bonds with one specific client is as important.

  • From what is heard otherwise in the market only a few (sporadic) cases of claims happened in judicial bonds, but none of significant magnitude (in terms of insured value).

  • To  date, there is very limited market evidence on claims which does not allow to draw any meaningful conclusion yet as to claims probability and recovery rates. In my view, the main concern is relates to how insurer’s responsibility under a judicial bond is treated if a claim occurs during the course of a chapter 11 situation. In this regard Oi’s still ongoing financial restructuring process may provide guidance and more clarity on how courts deal with claims, if the taxpayer is in a state of insolvency and how tax claims are treated in terms of ‘waterfall’ and seniority face to other corporate debt.

 

Conclusions

  • In our view, Judicial Bonds are a good example of a “new” product making its way to become an important premium contributor after an intense lobbying activity done by the insurance industry (a product only offered by banks is now offered by our industry).

  • The market has reached a size of around USD 300m in premium and surety companies can still see a potential for future growth.

  • While claims experience has been very good in the past, this is still a product with little history, at least in the surety industry.

  • Currently we encounter a challenging situation with a number of Brazilian risks which are in a situation of financial distress. It remains to be seen whether any of these names will produce an increased number of Judicial Bond claims going forward.

  • What is key, as is true for any surety bond product, is a diligent, professional underwriting of the relevant risk and I’m happy to announce that at one of the next PASA technical seminars - from what I’ve understood - this topic will be presented in more detail.

  • I hope that the more global perspective presented on judicial bonds in Brazil has been of interest.

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