Section P
Surety Bonds
Surety bonds (provided by an insurance company) are referred to just as bonds in the project management world. Alternately, surety can be provided by bank guaranties. Their purpose is to provide the client with a sum of money in the event that the contractor defaults. The alternative to a bond is for the client to ask for a parent company guarantee.
Bonds and guarantees are so dangerous that this section is limited to the basic information that a project manager needs to know. An expert should be consulted for anything else.
It is safest to think of them as big banknotes that can be cashed by anyone!
There are three parties involved in bonds and guarantees, and each has a different interest:
- The beneficiary (the client) wants to receive a compensatory sum of money if the contractor fails to meet their obligations
- The principal (the contractor) does not want to pay if they have met their obligations.
- The guarantor (or surety) wants to meet their commitment without becoming involved in possible disputes between the beneficiary and the principal concerning correct performance.
In the United Kingdom, the use of financial guarantees issued through banks has traditionally been fairly limited. The reason is, firstly, the financial status of a company can be reasonably well established. Secondly, it has been considered sufficient to rely on the contractual remedies that exist in the contract and trust in the legal system.
A common feature of guarantees is a requirement that the guarantor and contractor be jointly and severally bound under the guarantee. This gives the client the ability to make a claim against either the guarantor or contractor, although in practice it would invariably be the guarantor against whom the claim would be made.
The terms on demand and conditional are frequently used in relation to bonds. However, it should be recognised that most bonds are on demand if the terms of the bond have been complied with.
In the building and civil engineering industries, conditional bond formats have been the norm. However, in the mechanical and petrochemical engineering industries, on‐demand bonds tend to be used.
The current Uniform Rules for Contract Bonds were issued by the International Chamber of Commerce (ICC) in 2000.
1 Types of Bonds
- Tender bond
- Performance bond
- Repayment bond
- Customs bond
- Subcontract bond
- Retention bond
- Warranty bond
- Maintenance bond
1.1
The tender bond is requested with an enquiry in order to coerce the contractor to complete negotiating and signing the contract, should the tenderer be chosen as the successful contractor. If they don't sign the contract, then the client has a sum of money to cover the cost of re‐tendering the project.
1.2
The successful contractor will almost invariably be asked to convert their tender bond into a performance bond. The contractor basically has no option but to do so. The performance bond enables the client to use the value of the bond to get the project completed by someone else if the contractor fails to perform according to the terms of the contract.
1.2.1
See also Section J Joint Associations, paragraph 9.4.
1.3
A repayment bond is to enable the client to get their money back if an advance payment is to be made.
1.4
The customs bond makes sure that the contractor pays the customs duties that accumulate on the importation of goods.
1.5
The subcontract bond is insurance against the contractor not paying their subcontractors so that the client can use the monies to do so themselves.
1.6
The retention bond is slightly different in that it can be requested by the contractor. If the contractor would rather have the cash than let the client keep the retention monies, then the contractor can provide a bond to cover the sum involved. Nevertheless, the client is unlikely to agree to this mechanism until practical completion has been achieved.
1.7
A maintenance bond is similar to a performance bond in that it is insurance that the contractor will provide maintenance facilities and upkeep for a defined period of time.
1.8
Top up bonds exist! However, you have to have rocks in your head if you ever contemplate them.
The ‘top‐up’ refers to a contract condition, which is introduced by some clients. The condition provides that in the event of a call being made on a bond, the value of the bond must be made up to its original value. This is an extremely onerous condition, as in theory the client can keep on making calls under the bond with the guarantor having to ‘top up’ the bond each time to its original value.
2 Characteristics of Bonds
2.1
It is important to understand that the bond has a life of its own and exists as an entirely separate contract. This applies regardless of what it says in your contract and as to how the contract document may be collated and bound together.
2.1.1
The bond will be issued under the legal system of the owner's country.
2.2
Bonds have different periods of validity in different countries, and in some countries they never die. Nevertheless, it is good practice to quote a validity period since, in a dispute, it might help influence a decision.
2.3
The document should be returned to the bank as soon as possible after satisfying the contractual requirements. Bonds cost money every month that they are not returned to the bank that issued them. Consequently, it is essential that they are recovered. Help the client to find them if that is what it takes to get them back.
I spent four weeks helping an Egyptian client with their filing system in order to recover a $50m banknote.