A bond is a guarantee, issued by a third party in favour of the Beneficiary, that the contractual obligations of the Principal will be fulfilled. A Surety Bond is not a contract of insurance, but it does provide financial protection for the Beneficiary against loss if the Principal breaches contract and does not discharge damages.
Bonds are usually an undertaking by a bank or insurance company to make a payment in the event of non-performance of the contract by the contractor. On the whole, it may be advantageous to use a surety provider (insurance company) as opposed to the traditional banking method.
Why use a surety provider over a bank?
Banks generally take 100% cash collateral as security for the duration of the contract, which hinders cash flow. Therefore, using surety providers could help improve the contractor’s liquidity by freeing up bank lines for working capital needs. When using a surety provider, the bond sits away from the clients banking facility and does not have the same effect on the cash flow.
In addition, banks generally can extend overdraft facilities and it is likely they will be secured by personal guarantees or a similar mechanism.
What types of bonds are available?
There are a variety of types of bonds available and regularly used:
1. Performance Bonds
Primarily issued within the construction sector, this type of bond secures the performance of contractual obligations and provides an entitlement to payment against a Surety in addition to those available against the Contractor under the contract.
The value of a performance bond is usually expressed as a percentage of the contract price. It is usually between 5% and 20% of the contract price, with 10% by far the most common figure.
2. ‘On Demand’ Performance Bonds
This Bond provides independent obligation, requiring the Surety to make payment to the Employer. Wording will generally be in short form and expressed to become payable ‘on demand’ or ‘on first written demand’.
The Contractor or Surety cannot raise any contractual defence. Payment will normally be made notwithstanding protests by the Contractor and without any requirement on the part of the Employer to establish a breach of contract or that any damages have been suffered. The only defence is proven fraud.
On demand bonds give rise to the possibility of the employer issuing a demand to the guarantor where the contractor is not in breach of contract or insolvent, and no loss has been suffered. It is for this reason that on demand bonds cause problems for surety providers and as such it is extremely unlikely that any insurance company will facilitate the request. Banks will be more likely to consider.
3. Retention Bonds
Under standard contract conditions, the Employer will retain a percentage of each interim payment (typically 3% or 5%) to provide the Employer with funds to use in the event that the Contractor becomes insolvent or fails to rectify any defects during the maintenance period. The Contractor may request that the deduction of retentions is waived. To protect the early release, the Employer will ask for a Retention Bond.
Wordings are either conditional or on demand. The Surety market accepts that due to their very nature, and the fact that they are guaranteeing the release of a sum of money, an Employer would require an on demand bond. Because of this, on demand Retention Bonds are sometimes available.
4. Advance Payment Bonds
An Advance Payment Bond is required when a payment is made by the Employer to the Contractor in advance of work beginning. The Advance Payment could be for any amount and will not reflect a standard percentage of the contract value.
Wordings range between the ABI based conditional or outright on demand and as with Retention Bonds, on demand wordings are sometimes available.
5. Highway Act Bonds (Section 38/Section 104)
This bond guarantees the completion and maintenance of highways and sewers until adopted by the Local Authority. Typically, these will be required from developers of new estates.
What information is required to provide quotations?
- Two years audited accounts (consolidated in the case of a group of companies).
- Up-to-date management accounts for the current trading year.
- Completed application forms.
- A copy of the proposed bond wording.
- Completed schedule of bank facilities form and copies of any bank facility letters.
- Current workload schedule.
At Thomas Carroll, we have access to a wide range of surety providers and in-depth knowledge and understanding of the market. If you want to learn more, please contact us on 02920 853766 or email rhys.grant@thomas-carroll.co.uk.
