What is a Bond?
Employers use bonds alongside construction and engineering contracts to protect against contractor non-performance whereby a surety i.e. a bank or insurance company guarantees the performance of contractual obligations by the contractor to its employer. The value of the bond is usually 10% of the contract sum.
Types of Bond
A bond is designed to ensure that the contractor performs the works in accordance with the building contract. If the contractor fails to carry out the works, the employer will suffer a loss. The surety agrees to pay the employer for its loss up to a stated maximum sum, often originally set as a percentage of the contract sum and usually only for a limited time. A performance bond may be an on demand bond or default bond.
On Default Bond
The bond is called if the contractor fails to perform the contract. If this happens, the surety is required to prove the default of the contractor and only provide payment up to the extent of the employer’s loss.
On Demand Bond
The employer can call the bond without proof of default on the part of the employer.
Advance Payment Bonds
This type of bond is used by the parties where the employer has agreed to pay the contractor an advance payment under the building contract, for example site set up costs but is concerned that the contractor may not be able to perform the contract or repay the employer if something goes wrong. The employer will off set the risk of making the advanced payment by requiring an advanced payment bond to be provided by a bank approved by the employer.
Usually the employer and the contractor agree that the employer may retain a specified percentage (often 5%) of the amount certified as due to the contractor on an interim certificate, that is deducted from the amount due and retained by the employer. The purpose of retention is to ensure that the contractor completes the works required of them under the contract. When the project reaches practical completion, the employer pays half of the retention to the contractor. At the end of the rectification period, the employer releases the second tranche of the retention.
If the parties decide not to have a retention but the employer still wants some protection against the cost of remedying defects in the works, the contractor may agree to procure a retention bond. The sum covered by the retention bond reflects the sum that the employer would have held as a retention and, just like a retention, usually reduces after practical completion.
Form of Bond
As it is the surety that issues the bond, they will need to approve the wording of any form of bond.
The contractor must ensure that they include a price (within their tender) for 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.