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Bonded issues

Dennis Brand continues our look at bonds and guarantees with an outline of the different versions applicable in the construction industry.

COMMENT, Business

As we saw previously, contractors in the construction industry are commonly required to provide bonds or guarantees as performance security. These should be unconditional, on demand and issued by a bank that is acceptable to the employer. Examples of the types of bonds and guarantees available follows.

Tenders (bid bonds)

The purpose of the tender or bid bond is to encourage the submission of only serious tenders and ensure that the tenderer enters into the contract if it is awarded to them.

A specimen form of the bond will often be included within the invitation to tender package and the instructions will describe on what basis it is to be provided. The bond will usually have a required value of 2-5% of the tender price and a validity period at least that of the tender. The instructions to tenderers will often include a provision that in the event the tender must be extended, the tenderer will arrange for the tender or bid bond validity to be similarly extended.

 

Where a tender is successful, the employer will retain the bond until the performance bond is provided, whereupon it is returned to the tenderer for cancellation. Unsuccessful tenderers will have their tender bonds returned to them once the contract has been signed.

Advanced payment

It is not unusual for a tenderer to request an advance payment. The amount involved is a matter for commercial discussion, however a figure of around 15-20% of the tender price would not be considered exceptional.

The main argument for requesting an advance payment is to ease cash flow. No contractor willingly funds the works themself and without an advance payment they may have to arrange some form of financing facility, the cost of which they would include in the tender price. An advance payment from the employer therefore ultimately benefits both parties.

The form of advance payment bond is not always included in the invitation to tender package but most employers will provide a specimen form of bond. This will usually be what is termed a "reducing guarantee".

This in effect means that within the bond wording there will be a mechanism whereby its value will reduce as the employer recovers the amount of the advance. For example, where an amount is certified for payment to the contractor, a sum equal to say 10% of that sum will be deducted. At the same time, either automatically or following presentation to the issuing bank of a copy of the interim certificate, the value of the bond will be reduced by an amount equal to that deducted by the employer.

Typically the advance payment bond will remain valid for the life of the contract or until the advance is recovered. The purpose of the guarantee is as security for when the advance must be repaid. In the case of termination, if the contractor fails to repay the advance or its outstanding balance, the employer may make demand on the advance payment bond.

Performance security

In order to provide some security of performance to the employer, the contractor will often be required to provide a performance bond with a typical value of 10% of the contract price. In the event of default, demand is made in respect of the bond and the bank will pay the value to the employer. Usually there is no requirement within the contract for the employer to use monies recovered under the bond for any specific purpose in relation to additional costs incurred because of the contractor's failure.

A performance bond should be in place from the date of the contract or within a specified period of that date and remain in force until the issue of the defects liability or final certificate. It is sometimes not fully understood that the contractor's performance obligations extend during the defects liability or maintenance period as well as during the works period.

Retentions

A contract will often include a retention provision that allows the employer to deduct and retain an amount of money from each payment due to the contractor. Typically this is 10% of each payment due, up to a maximum of 10% of the contract price.

Usually a retention provision will provide that 10% of each payment due to the contractor be retained by the employer until completion of the works. The retention provision then provides for half the retention to be released to the contractor upon the issue of a taking over certificate, reducing the retention to 5% of the contract price.

Often a contractor will request the release of the remaining 5% against a bank guarantee of equal value. The reason for this is cash flow and it is down to the employer's discretion whether they agree.

The contractor's argument is that a retention guarantee will give the employer the same degree of security as they would have by continuing to retain the cash. From the employer's side, while a bank guarantee provides similar security as cash, in the event of default by the contractor, they must make a demand on the guarantee, but with cash in hand (literally) this is unnecessary.

Dennis Brand is senior legal advisor with Berrymans Lace Mawer. Tel: +971 4 359 9939

Bonds and guarantees: the types in brief

• A tender or bid bond is intended to ensure the submission of only serious tenders and that the winning tenderer enters into the contract. This will usually have a value of 2-5% of the tender price and a validity period at least equalling that of the tender.

• A tenderer may often request an advance payment to ease cash flow, with 15-20% of the tender price a usual value. This will usually be termed a ‘reducing guarantee', its value decreasing as the employer recovers the amount of the advance.

• A contractor must often provide a performance bond, with a typical value of 10% of the contract price. In the event of a contractual default, the employer will make a demand in respect of the bond and the bank will pay them this value.

• An advance payment bond will typically be valid for the contract life or until the advance is recovered.

• A contract will often include a retention provision that allows the employer to deduct and retain an amount from each payment due to the contractor; typically this is 10% of each payment due. Once the contract is complete this should be returned to the contractor.
 


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