Construction Security and Performance Documents

Question 1

What is a Bond?

Answer 1

Bonds are means of protection against the non-performance of the contractor. They are an undertaking by a bondsman or surety to make a payment to the client in the event of non-performance of the contractor.

Intends to encourage performance

Typically expire on PC date

Cost of the bond usually borne by the contractor, although likely to be reflected in their tender price

Question 2

Rules of Bonds?

Answer 2

Must be in writing and in the form of a deed

Duration depends on the terms given by guarantors

Financial limit of liability are expressed in the contract of guarantee

Question 3

What are “On Demand” & “Conditional” Bonds?

Answer 3

On Demand
• Value of bond can be raised straight away

Conditional
• Requires the client to provide evidence that the contractor has not performed their obligations under the contract and that they have suffered loss as a consequence

Question 4

What types of bonds are there in construction?

Answer 4

• Performance bond
• Advanced payment bond
• Off-site materials bond
• Retention bond
• Defects liability bond
• Adjudication bond

Question 5

What is a performance bond?

Answer 5

A bond that insures a client against the risk of the contractor fulfilling contractual obligations to the client

Typically set at 10% of the contract value

Cost of the actual bond is typically 1% of contract value (dependant on financial stability contractor)

Usually Conditional

Section 7 of JCT

Example would be if contractor went insolvent, the bond would finance the employer to re-tender the works

Question 6

What is typically included within a performance bond?

Answer 6

Parties names (Contractor / Guarantor / Employer)

Background (refer to contract, the works, limitations)

Deed witnessed (guarantor guarantees to the Employer that in the event of a breach of the contract by a contractor or termination of the employment of the contractor)

Maximum aggregate liability of the guarantor and the contractor under the bond

The laws that govern bond e.g. England and Wales

Benefit of the contract may be assigned to the guarantor

Company numbers & addresses (contractor / guarantor / employer)

Bond Amount

Expiry date of bond e.g. date of issue of certificate of making good defects

Execution as a deed

Question 7

Disadvantages of “On Demand” Performance Bond?

Answer 7

More expensive to client

Negative impression on contractor

Parent Company Guarantee can sometimes be better as Parent company can step in and fulfil all of obligations of the insolvent contractor

Question 8

What is an advanced payment bond?

Answer 8

Schedule 6 Part 1 OR Contract Particulars 4.6

If the client agrees to make an advanced payment to the contractor (e.g. where the contractor incurs significant start up and procurement costs before construction begins) a bond may be required to secure the payment against default by the contractor.

Usually on Demand

Taken out by Contractor

Question 9

What happens if the Bondsman disputes the amount?

Answer 9

If the guarantor refuses to pay because it disputes the actual amount, it will be liable for interest and costs as a result of it’s delay.

Question 10

What is an Offsite materials bond?

Answer 10

Schedule 6 Part 2 OR Contract Particulars 4.15.4 / 5

It can sometimes be appropriate for the client to pay for items even though they remain off site e.g. plant or materials.

Bond secures payment against default by the contractor

Usually on demand

Usually up to the value of the materials offsite, with the value of the bond reducing as deliveries to site are made

Question 11

What is a defects liability bond?

Answer 11

Can be used to ensure that the contractor continues to provide services rectifying defects that become apparent after PC has been certified.

Usually on demand

Question 12

What is an adjudication bond?

Answer 12

Can be used to ensure that the contractor continues to provide services rectifying defects that become apparent after PC has been certified.

Usually on demand

Question 13

What is a Retention Bond?

Answer 13

Schedule 6 Part 3 OR CP 4.17

Retention bonds are way of avoiding problems associated with retention recovery.

Amounts that would otherwise have been held as retention are instead paid, with a bond being provided to secure the amount.

Contractor pays for bond but usually reflected in their tender price

Bond must be increased for variations during the project. If not increased during the project, then the % percentage can be taken against variations through interim valuations

Similar to retention, the bond’s value will usually reduce after the certification of practical completion.

Question 14

Why may a retention bond be used?

Answer 14

May be used in difficult market conditions to aid the contractor’s cashflow

Question 15

Disadvantages of retention bond?

Answer 15

Employer pays a premium on taking out the bond

Harms the employers cashflow

May reduce the contractor’s incentive to complete works to a good standard and promptly

Question 16

What is a Tender Bond?

Answer 16

Submitted by a tender to ensure a successful tenderer’s commitment to commence the contract

Used to make sure the contractor successfully executes the contract

Typically set at 1-5% of contract sum

Normally on demand

Rarely used in the UK, more international

Usually used with main contractor’s and subcontractor’s

Question 17

What is a Parent Company Guarantee?

Answer 17

A company that controls another subsidiary company is known as a “Parent Company”

A form of security that may be required by clients to protect them in the event of default on a contract by a contractor that is controlled by a parent company.

The parent company guarantees that in the event the contractor defaults on their obligations, the parent company is required to remedy the breach, meeting all the contractor’s obligations under the contract.

Includes latent defects up to 12 years

Often used as an alternative to a performance bond

Not all companies have a parent company

Can be considered a negative as if the contractor goes insolvent there is risk that the Parent Company may also be in financial difficulty

Question 18

Client confused whether to go for Performance Bond or Parent Company Guarantee, what would you advise?

Answer 18

Parent Company Guarantee might be suitable, as allows Parent Company to fulfil obligations of contract for Subsidiary Company. In the event the contractor goes insolvent – will the Parent Company have financial problems too? Due diligence would need to be carried out on Parent Company

Bond you have to pay for, contractor will pass on cost to Client

Question 19

What is Assignment?

Answer 19

Transferring the benefits of the contract

E.g. Collateral warranties / Third party rights

Question 20

What is Choses in Action?

Answer 20

Property rights

Question 21

What are collateral warranties?

Answer 21

Agreements, which are associated with another primary contract. They provide a duty of care to be extended by one of the contracting parties to a third party who is not party to the original contract.

Create direct contractual relationships between parties that would not otherwise exist

Question 22

Where would you find Collateral Warranties?

Answer 22

Must be stated in contract documents or amendments (details must include the number, format and from whom)

Stated in the Contract Particulars if they APPLY and who they are between

Question 23

Duration of Collateral Warranties?

Answer 23

Usually duration of limitation period of contract (6 or 12 years)

Question 24

Advantages of collateral warranties?

Answer 24

Provide protection against hidden defects which may only become apparent sometime after the completion of the project

Bypasses the privity of contract (private to the parties in the contract) & Allows third parties to claim benefits of contract (e.g. if the subcontractor went bust then the employer would have no link to them due the privity of the contract between the contractor and the subcontractor)

May include step in rights allowing the beneficiary to step into the role of the employer. This is important to funders of a project

Clearly sets out benefits

Industry is familiar

Easy to call upon if disputes arise

Question 25

What are the disadvantages of collateral warranties?

Answer 25

Difficulty completing them as on large projects there are many consultants and so can be a great number of warranties

“The contracts (rights of third party)” can offer a way around this difficulty by allowing the primary contracts to confer benefits upon third parties even though they are not party to the contract

Question 26

Which parties may have a collateral warranty in place?

Answer 26

Client with subcontractor’s

Main contractor with subcontractors who will be designing

Client with any Contractor’s Design Portion (E.g. MEP, cladding specialist, joinery specialist etc.)

Funder with developer

Purchaser with architect / developer

Question 27

So how is a collateral warranty different to The Contracts (Rights of Third Party)?

Answer 27

TPRs offers an alternative to Collateral Warranties

The right created is to enforce a term of a contract, not the whole contract itself

However, the contract must expressly state that a third party has specific rights for the Third Party Rights Act to apply, and often these are excluded. Third party rights are typically provided for by way of a notice stating that the third party is entitled to rely on specific provisions of the contract.

However, collateral warranties can be perceived as being more effective since they mirror the responsibilities of the underlying contract. The construction industry is also more used to using them.

Question 28

What are the 3 ways that benefits can be transferred under JCT contracts?

Answer 28

Collateral Warranties

Third Party Rights

Assignment

Question 29

Who might want a collateral warranty?

Answer 29

Any Third party with a financial institution in a project but not party to the main contract (funder, future tenant / purchaser)

Employer may want a collateral warranty with a key subcontractor, as if the main contractor were to go insolvent, they would have no contractual link with them for redress of defective works

Question 30

What are the common clauses / terms in Collateral Warranties?

Answer 30

• The obligations of the collateral warranties should mirror that of the main agreement

• Therefore if a party is in breach of the main agreement they would also be in breach of the warranty
o Limitation of liability
o Details of what they are responsible for (e.g. design work)
o The process in the event of employer/contractor insolvency
o Reasonable Skill and care V fitness for purpose
o Requirement for PII
o Assignment Rights
o Novation Rights