Bonds in construction contracts
Bonds are a means of protection against the non-performance of the contractor. They are an undertaking by a bondsman or surety to make a payment to the client in the event of non-performance of the contractor. The cost of the bond is usually borne by the contractor, albeit, this is likely to be reflected in the contractor's tender price.
Bonds can be 'on demand' or 'conditional', with conditional bonds requiring that the client provides evidence that the contractor has not performed their obligations under the contract and that they have suffered a loss as a consequence.
NB See also bonds v guarantees.
A performance bond is commonly used as a means of insuring a client against the risk of a contractor failing to fulfil contractual obligations to the client, although they can also be required from other parties.
Performance bonds are typically set at 10% of the contract value. This compensation can enable the client to overcome difficulties that have been caused by non-performance of the contractor, such as, finding a new contractor to complete the works.
For more information see Performance bond.
If the client agrees to make an advance payment to the contractor, (for example where the contractor incurs significant start up and procurement costs before construction begins), a bond may be required to secure the payment against default by the contractor. This will normally be an on-demand bond.
For more information see Advance payment bond.
It can sometimes be appropriate for the client to pay for items even though they remain ‘off-site’, for example, where a contractor has made a large payment for plant or materials that have yet to be delivered to site, or if the client wishes to ‘reserve’ key items in order to protect the programme.
This is similar to the situation where an advanced payment is made in that a bond secures the payment against default by the contractor and is likely to be an on-demand bond. The bond might be up to the value of the off-site items, with the value of the bond reducing as deliveries to site are made.
Bid bonds are rare in the UK, but can be a requirement of an international tender process. They are usually on-demand bonds submitted with a tender to secure the tender's commitment to commence the contract. The bond is partially or fully forfeited if the winning tender fails to execute the contract or meet other specified conditions.
Retention is a percentage (often 5%) of the amount certified as due to the contractor on an interim certificate that is retained by the client. The purpose of retention is to ensure the contractor properly completes the activities required of them under the contract. Half of the amount retained is released on certification of practical completion and the remainder is released upon certification of making good defects.
An alternative to retention is a retention bond, where the client agrees to pay the amounts which would otherwise have been held as retention, but instead a bond is provided to secure the amount that would have been retained. As with retention, the value of the bond will usually reduce after practical completion has been certified.
The defects liability period (now called the 'rectification period' in Joint Contracts Tribunal (JCT) contracts) begins upon certification of practical completion and typically lasts six to twelve months. During this time, it is the contractor's responsibility to rectify any defects that become apparent in the works.
A defects liability bond can be used to ensure that the contractor continues to provide services, rectifying defects that become apparent after practical completion has been certified. This is generally an on-demand bond that may be required on projects where there are no remaining payments to be made, or other security such as retention, after practical completion.
Adjudication bonds are conditional bonds that have emerged on PFI/PPP projects and are payable on an adjudicator's decision. Adjudication bonds are most suitable when the adjudicator’s decision is final and binding. If this is not the case, (ie the adjudicator’s decision is an interim one) complex procedures are necessary to balance payments if subsequent dispute resolution procedures reach different decisions.
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