BONDS C&L Preview. Introduction. What is a bond? Types of bonds. On default bond. On demand bond

Transcription

1 BONDS C&L Preview Third Edition September 2012 Introduction There are three collateral arrangements that can be used to secure the performance of the obligations undertaken by you. This issue focuses on the use of Performance Bonds (Parent company guarantees and retentions are dealt with elsewhere). Remember, under most forms of contract, if you fail to perform, the Beneficiary will have recourse to a retention fund in addition to his other contractual remedies, such as set-off and arbitration. A Bond therefore gives the Beneficiary additional security for your performance. What is a bond? A Performance Bond is a document usually executed as a deed (under seal), whereby a surety (normally a bank or insurance company) guarantees your contractual obligations to its employer. The value of the bond is usually 10% of the contract sum. Types of bonds On default bond What the Bond is usually called, if you fail to perform the contract, in which case the Surety is then required to prove your default and only provides for payment up to the extent of the Beneficiary s actual loss. The Surety will join you in fighting any unjust claims and taking action to minimise loss. The terms of the Bond should require, as a precondition to payment, the breach of contract to be admitted or proved in arbitration or litigation. On demand bond These should be avoided where at all possible. Usually issued by a Bank, the Beneficiary can call on the Bond without proof of your default. If the value of the Bond is offset by the Bank, through a counter-indemnity, against your credit facilities, often you might as well write-off the value of the Bond. You should therefore cater for this risk within its price. Building & Engineering Services Association Esca House, 34 Palace Court, London W2 4JG T commercial&legal@b-es.org

2 In order to recover the monies paid under the Bond you would have to prove that it was not in default (with the expense of doing so). The threat of calling the Bond can therefore be used by the Beneficiary as a tool within any claims negotiation process or as a means of income by Beneficiary experiencing financial problems. Reducing bonds The Bond reduces progressively as the job proceeds and each reduction is conditional upon the achievement of a defined stage of the works. For example the Bond; commences at (say) 10% of the contract sum, reduces to 5% when half of the total contract sum has been certified, reduces to 2.5% when three quarters of the contract sum has been certified and reduces to nil on the issue of the Certificate of Practical Completion. This is more advantageous to you although not frequently used in the market place. Bonds in favour of multiple parties This equates to you giving one Bond in favour of more than one party severally rather than separate Bonds for each party. Severally means there is a possible liability to each of the beneficiaries. A multi-party Bond for 10% of the contract sum in favour of two beneficiaries is therefore in reality a 20% Bond. Advanced Payment Bonds This is where you receive an advance payment to finance the initial stages of a contract such as site set up costs, design costs etc. In these circumstances, the payer will offset the risk of making the advanced payment by requiring an Advanced Payment Bond and/or Guarantee (usually conditional upon receipt of the advanced payment but on demand ) to be provided by a Bank approved by the Employer. Advanced Payment Bonds often contain a reducing liability clause whereby the Bond reduces as the work progresses. This is done by deducting from monthly valuations a proportion of the advance payment until eventually the advance payment has been accounted for. Retention Bonds Some contracts provide, on condition that you supply a Retention Bond (sometimes called a Warranty Bond and nearly always on demand ), the retention monies will be released to you on practical completion (the Employer swaps one method of security (the Retention Monies) for another (Retention Bond). This allows the employer to give the contractor a cash flow advantage by abandoning the retention mechanism and in exchange the employer is given Building & Engineering Services Association 2 of 5

3 security by way of a retention bond from you and allows the employer to avoid the duties, liabilities and operation of the retention sums. Overseas Bonds Performance Bonds are almost invariably required on overseas jobs (often on demand ). If the employer insists that it is provided or at any rate countersigned by a National Bank in his country this may cause you both financial and legal problems. To avoid the additional costs, problems and risks associated with the issue of Bonds by overseas correspondent banks, you are best placed if the UK Bank gives a Bond direct to the foreign employer. A viable compromise may be where the UK bank issues the Bond through its relevant foreign branch. Bid/Tender Bonds Usually encountered on overseas jobs, you may be required to procure a Bid Bond (usually on demand ). They protect an employer from wasted bidding costs and the costs of re-tendering the contract. This form of Bond is comparatively rare in the United Kingdom and is only likely to be encountered in a situation of public competitive tendering which can often amount to between 1% and 2% of the tender amount. The purpose of this Bond is to assure the Overseas Purchaser that the successful bidder will execute the contract at the request of the client and begin to implement the works in accordance with the tender requirements and the bid is legitimate and therefore the bidder will not unilaterally withdraw during the bid validity period thereby causing delay and possibly additional expense to the client. Sources of bonds and cost implications Firstly, within your tender you should include a price for your bearing the risk of having to issue any counter-indemnities or personal guarantees requested by the Surety as security for issuing the Bond and the fee charged for issuing the Bond. The main sources of Bonds are the Clearing Banks, Specialist Surety Companies and certain Composite Insurance Companies. Banks experience of a Client s affairs and less complex underwriting approach to Bonds mean it is often simpler and quicker to obtain a Bond from a Bank. However, Banks generally do not wish to become involved in any litigation over the calling of a Bond and since their reputation is dependent on honouring their Guarantees promptly and without demur, they will generally only agree to provide on demand Bonds subject to off-setting the value of the Bond against their Customer s credit facilities. A bank will treat the sum guaranteed by the Bond as an extension of your credit facility. Unless you have a separate facility for bonding, the bank is likely to reduce your overdraft limit by the amount of the Bond. Building & Engineering Services Association 3 of 5

4 Insurance Companies underwrite Bonds on an unsecured basis by careful examination of the contract conditions and your ability and standing. For this reason if you approach a Surety or Insurance Company will have to provide considerable information of your past performance generally much more than appears in a Company s published accounts to allow the insurer to perform this review process known as due diligence. You should therefore endeavour to establish with a Surety or Insurance Company an ongoing bonding facility in order to avoid having to repeat this process on each occasion when a bond is needed. Surety and Insurance Companies will generally only provide default Bonds. An insurer is not likely to request the deposit of the requisite sum as a bank would, but will instead off-load the risk by re-insuring against it. The Surety will require a Counter Indemnity under which you indemnify the Surety against any liabilities it may incur if the Bond is called and against all claims, demands, proceedings, damages, costs, charges and expenses whatsoever in respect thereof or in relation thereto. As Surety and Insurance Companies underwrite Bonds on an unsecured basis, they may in certain instance wish to take some legal charge on the assets of the Contractor (or Sub-Contractor) and possibly obtain personal guarantees from Directors. Common provisions As it is the bank/surety/insurer that will issue the Bond, they primarily will need to approve the wording of any draft Bond. Where possible the following position should be maintained within the provisions of the bond: your liability should expire upon a definite date and not a date which is unascertainable or may not happen; your liability should be capped at 10% of the contract value and ideally expressed to be inclusive of interest and legal costs whether due from you or the bondsman otherwise these will be costs in addition to your liability and that of the surety s liability under the Bond; payment under the Bond should be conditional upon the Beneficiary proving to the surety: i. your breach of the contract, and ii. the amount of loss caused by such breach; notice of your default or the Beneficiary s intention to claim, should be a precondition of the Beneficiary s ability to claim under the Bond; Building & Engineering Services Association 4 of 5

5 exhaustion of prior remedies against you or the obtaining of an award or judgment should be a precondition of the Beneficiary s ability to claim under the Bond; the surety should have the option of being able to perform the remaining works in order to reduce costs and therefore reduce the burden placed on the counter-indemnity against you; your ability or the Beneficiary s ability to assign its rights should be limited to its ability under the underlying construction contract to do so. Judge for yourself whether you can afford to expose your organisation to the risk of an on-demand bond or you ought really only to ever issue on default bonds and whether you are best served asking your insurer or your bank to issue the bond. Charlotte Barker Legal Adviser & Solicitor Building & Engineering Services Association 5 of 5