By Thrings Solicitors
Construction security can be essential for providing an additional layer of protection for employers, developers and their funders against contractor non-performance under a construction contract.
A large part of any construction project’s success will depend on the contractor meeting the programme, completion dates, specifications and its obligations under the contract. Bonds or guarantees as additional construction security can be vital in an economically unstable time.
Natalia Sokolov, Head of Construction at Thrings Solicitors, looks at the main types of construction security and how you can protect your project against risk.
Types of security
The main types of construction security are:
On-demand bond
This is a financial requirement on a bank or third-party bondsman to make an immediate payment following a demand. There is usually no requirement to prove a breach of an underlying contractual obligation before the on-demand payment is made.
In construction, on-demand bonds can take the form of an advanced payment bond, retention bond or performance bond among others. Generally, these are intended to ensure the meeting of obligations under the construction contract, and the bond would usually cover 5–15% of the contract sum. The maximum amount available under the bond may not, therefore, cover the employer’s total loss.
Resisting a call on an on-demand bond can be difficult and usually requires an injunction against the bank or person seeking to make the call. Ultimately, the contractor may obtain the bond, but the cost would be passed to the employer, as part of the premiums or contract pricing strategy.
Guarantee
This would require a breach of contract to be established before any payment is made. This creates a secondary obligation to pay, rather than one of an on-demand nature.
The guarantor is usually party to the underlying contract, such as a parent company of the contractor. For a parent company guarantee, we would expect the ultimate parent company to provide the guarantee, rather than the immediate parent within the group of companies of which the subsidiary forms a part.
The financial strength of the parent company impacts on the strength and value of the guarantee. In the event of insolvency of the contractor under a parent company guarantee, it is likely that the parent company’s ability to pay is also at risk, and the employer’s recoverability may therefore be reduced.
Hybrid security
Some bonds are more palatable to contractors if they are drafted in a ‘hybrid’ manner. This type of guarantee would include an on-demand clause for instances of insolvency of the contractor, and on-default (payment on demonstrable breach) for material breach of contract for example. In our experience, we have found this type of bond can prove less expensive to obtain, and easier to negotiate, on occasion.
Some practical tips:
- Cost and requirement – The drafting of a security document can impact the cost. Often the language used can be unclear and the title of the document may not reflect its content. If the contractor has a good financial standing, and there is a good long-term relationship between employer and contractor, the parties may be comfortable waiving the requirement for costly additional construction security.
- Check the financial stability and jurisdiction of a bondsman offering security – Check this beforehand, as well as where the bondsman is based, as it could impact the strength of your security. If they are abroad, enforcing the security or transferring assets could be costly and time consuming.
- Ensure drafting provisions are straightforward – Whether it is the expiry date, grounds for making a demand, the law/jurisdiction clauses or the exit/termination provisions, make sure the wording is clear and unambiguous. We would expect the bond to extend to at least the date of practical completion, and, ideally, to the end of the defect period to protect the developer against non-performance for the duration of the contract.
- Seek legal advice early on in the process – This should be your first action before making a demand or resisting a call to ensure you are fully informed before attempting to tackle any issues.
Contact Natalia Sokolov (nsokolov@thrings.com) in Thrings’ Construction & Engineering team for advice and support.
