Bonds and Parent Company Guarantee

Question 1

413 What is a bond?

Answer 1

Bonds are a protection for the Client against non-payment, lack of performance, company default and warranty issues. Or an arrangement where the contractual duty of one party to another is backed by a third party.

Question 2

414 Name 5 different bonds that might be issued on a construction project?

Answer 2

Performance, Retention, Off site materials, Advanced Payment and Tender.

Question 3

415 What is a performance bond?

Answer 3

It is a security provided by the contractor to the Client. Consists of an undertaking for a bank or financial institution to make a payment to the Client in circumstances where the contractor defaults on their contract

Question 4

416 When might the employer want a performance bond?

Answer 4

Where there is risk of the contractor becoming insolvent/ where the economy is at risk of recession. Where certain elements of the project are critical to the employer like completion. Or where there is not a parent or holding company to provide financial stability.

Question 5

417 What is the difference between an on demand and a conditional bond?

Answer 5

With a conditional bond the contract must have actually defaulted whereas with a on demand bond the Client can call it in if the contract is reasonably expected to default on their obligations.

Question 6

418 What is the typical value of a performance bond?

Answer 6

10% of the contract sum.

Question 7

419 What is the typical cost of a performance bond?

Answer 7

Depends on the financial stability of the contractor and the number of previous claims.

Question 8

420 What is the risk of not having a performance bond?

Answer 8

If the contractor becomes insolvent the Client may incur additional cost to complete the works.

Question 9

421 Are there any alternatives to performance bonds?

Answer 9

Yes. Parent company/holding company or ultimate holding company guarantees.

Question 10

422 What is a tender bond?

Answer 10

Requested by the Client of the contractors in a bidding process. Provides security against the risk of the successful bidder failing to enter into contract.

Question 11

423 What is an offsite materials bond?

Answer 11

A security that covers materials that have been purchased for the project but are currently being held offsite (because of space issues/not yet required or for long lead items. Used when the contractor becomes insolvent so they Client can still obtain the good they have paid for.

Question 12

424 What is a retention bond?

Answer 12

Type of performance bond and is used as if the contractor fails in their duties under the contract, for example, to rectify a defect after contract completion.

Question 13

425 What are the disadvantages of a retention bond?

Answer 13

There will be a cost to obtain the bond from the guarantor. May reduce the contractors incentive to complete the works on time and to the desired standards (if the retention is withheld from the contractor, he will have to fix defects to get paid the retention.

Question 14

426 Why might a retention bond be used?

Answer 14

If money is withheld through retention, then the contractor might have to finance the money, they are not getting paid for that work at that time therefore the overall cost of the project might be higher. If the retention is through money held once past a trigger point, that point has not been reached and the contractor becomes insolvent there will be no money for the Client to draw down on and finish the works. If a retention bond is used, the bond is held by a finically stable (in theory institution). Might be used to aid the contractors cash flow.

Question 15

427 What is an advanced payment bond?

Answer 15

This is when a security is offered up for materials that are purchased before the contract is signed or in the early stages. It covers the money the Client has paid out and ensures that it either receives the goods or the money back.

Question 16

394. What is a parent company guarantee?

Answer 16

A form of security that might be required by Clients to protect in the event of a default by a contractor that is controlled by a parent or holding company. Default might be caused by insolvency or breach/non-performance of contract.

Question 17

395 In what circumstances might a Parent Company Guarantee be required?

Answer 17

Where a small contractor is part of a larger parent/holding company that is financial stable. Should the contract default on or breach the contract then the parent/holding company may step in to remedy this.

Question 18

396. Are there any acts that govern the rights of third parties?

Answer 18

Yes, the Contract (Rights of third parties) act 1999 gives parties the right to enforce contracts that confirm benefit on them expressly through the manner in which the contract has been written (implied) even if they are not party to the contract. It also sets out remedies if those contract terms are breached.

Question 19

398 What are the advantages of using Third Party RIghts Clauses?

Answer 19

Time and cost. As you don’t have to draw up collateral warranties it will save time and cost
Subcontractors. This can be extended to their contracts as well so the third party will have the same rights over their works.

Question 20

399. Disadvantages of Third Party Rights Clauses?

Answer 20

Lack of flexibility. Once it has been conferred and agreed there is limited room for negotiation and can cause a problem if a specific provision is required for say an incoming tenant or purchaser.
Careful drafting is required. For example around the right to commence adjudication.

Question 21

400. Why might third party rights be used instead of third collateral warranties?

Answer 21

If a lot of collateral warranties are required it might take a lot of time to administer. Third party rights are quicker to get into place because there is no separate document.

Question 22

410 What is assignment?

Answer 22

Assignment is when one party is given the benefits of a contract without carrying any of the burden which rests with the original party.

Question 23

411 Where might this be used?

Answer 23

If a project is being funded by a bank or financial institution, they may wish to have some benefits assigned to them. If say the borrower (the Client under the construction contract) becomes insolvent the funder may wish to have the benefit of stepping in to finish off the project so they aren’t financially exposed.