Last edited 04 Jun 2018

Surety

The risk of contractor insolvency or default is always a concern for construction clients. It can have a serious knock-on effect on the whole project, and can, in worse case scenarios, stop a project completely.

A surety, (sometimes referred to as a bondsman or guarantor), takes responsibility for another party's performance. In the case of construction contracts, a surety may undertake to make a payment to the client (or undertake some other corrective action) in the event of non-performance of the contractor. Generally, a surety is a bank, bond company or insurance company.

This guarantee, sometimes referred to as a 'performance bond' or 'surety bond', is generally a requirement of the contract, and typically provides that in the event of a contractor default, the surety guarantees to pay the client’s damages, say up to a maximum of 10% of the contract sum. This payment can enable the client to overcome the difficulties caused by the non-performance, such as finding a new contractor to complete the works.

The cost of the bond is usually borne by the contractor, although this is likely to be reflected in the contractor’s tender price.

In the event of the contractor’s default, or the possibility of default, the surety will begin by assessing the situation to determine their liability and the best course of action. The contractor and the surety should cooperate on finding a resolution of the issue, including trying to avoid default in the first place. If the surety finds that the bond’s principal (the contractor) has defaulted, then there are valid grounds to claim against their bond.

There are then several approaches that can be taken:

Takeover - The surety assumes control and oversees the completion of the contract, often involving hiring a new contractor. This is common where projects are near completion.
Tender - The surety seeks a new contractor to complete the contract, but does not assume project control.
Contractor assistance - The surety provides the defaulting contractor with additional resources and financial assistance. This can be appropriate where there is a pre-existing relationship between the contractor and the surety.
Obligee completion - The surety opts to let the obligee (the client) complete the project. This strategy can be adopted where the client’s plans for completion are reasonable and do not open the surety to further risks.

Bonds can also be required from other parties to a construction contract, such as consultants or suppliers.

As construction contracts are generally subject to change during the course of a project, the liability of surety will generally not be removed by alterations, variations or waivers of the underlying contract. These provisions are sometimes referred to as ‘indulgence clauses’, and mean the contractor does not have to continually seek permission from the surety whenever amendments need to be made.

However, this is generally a limited provision; if amendments create new or more onerous obligations, rather than simply varying the existing obligations, then permission may need to be obtained in advance.