13th March 2018
Focus – Bonding for construction projects

How bonding can provide valuable additional cover for construction risks

In the UK, bonding has long played a part in securing major infrastructure projects and public works, but now it’s increasingly being employed in the private sector, especially for larger contracts. If you have clients involved in construction work of any kind, then they really should consider how bonds can be used to protect their financial and legal interests.

Construction projects typically involve multiple contractors who have a variety of tasks to perform that must be delivered within strict time-frames. If one party to the project experiences problems performing their portion of the work, then it can have a serious knock-on effect on the entire venture. Ultimately, if they default, then the project could be in jeopardy, and the costs may increase considerably.

Developers may demand that a contractor provides a bond if they are concerned about being financially exposed. Alternatively, contractors may use it as a demonstration of their reliability.

How bonds work

In simple terms, a bond is a financial guarantee issued by an insurance company or bank, termed the surety, that guarantees to a client that a supplier will satisfactorily complete their obligations under their contract. If they don’t, the client will be compensated by the surety for any monetary loss up to the amount specified in the bond.

There are different types of bonds that can each play a major role in securing financial risks; here are some of the main types:

Advanced Payment Bond

If a client agrees to make an advanced payment (often referred to as a down payment) to a supplier, a bond may be required to secure the payment against the risk of the supplier defaulting. Typically, in a construction scenario, the advanced payment could cover the acquisition of plant, equipment or materials specifically required for the project.

Performance Bonds

These are a form of guarantee against possible losses in a case where a supplier fails to perform, or is unable to deliver their responsibilities as stipulated in the contract. If they default, or go into bankruptcy, the surety is responsible for compensating the project owner for the loss.

Retention Bonds.

These enable the early release of funds that would otherwise be withheld until the satisfactory completion of any warranty period set out in the contract. Offering a retention bond, rather than opting for cash retention at the end of a project, can represent a win-win situation for both client and contractor. The client has the monetary protection it requires, and the contractor keeps hold of its cash. In the event of any problems, if the bank or insurance company is satisfied that any alleged default is proven, it will pay out and seek recovery from the defaulting party. Retention bonds come in two types, ‘conditional’ and ‘on demand’.

Conditional or On Demand Bonds

Conditional Bonds are also issued by banks and major insurers and, as the name suggest, will pay out if the supplier fails to meet their contractual obligations. On Demand Bonds are also available, but less-commonly used as they require the surety to make immediate payment.

The benefits that bonds provide

  • They can be tailored to suit the needs of both parties to the transaction
  • Putting a bond in place helps providers of goods or services demonstrate their ability to meet the terms of a contract, backed by the undertaking provided by the surety.

Focus View – Toby Catlin, General Manager

Contractors in the construction industry tendering for projects can struggle with the need to provide guarantees surrounding performance, but surety-backed bonds can offer a solution. Surety bonds offer an alternative to bank guarantees for the purpose of contract security and performance pledges.

Using a surety rather than relying on a bank can have a positive effect on a contractor’s working capital. Banks prefer to issue bonds in “on demand” form, meaning that they must treat them as unpresented letter of credit. If a bank issues a bond, then the amount involved is deducted from any borrowing facility they currently have in place, thus potentially limiting their scope for future borrowing.

A surety bond has the practical benefit of being a separate facility. A bond backed by a bank is only an indication of financial capability, whereas if a contractor has been prequalified by a surety it provides a greater degree of confidence and can be instrumental in a contractor being awarded a contract.

How we can help

If you have any queries, or would like more information about the range of bonds we offer, then please do contact us on 0345 345 0777.