Performance Bonds and Guarantees

Performance Bonds and Guarantees

Performance bonds and parent-company guarantees are risk-management tools used in construction projects. They can reduce the financial and operational impact of contractor default, defective work, delays, or insolvency.

How They Work

• Performance bond: Typically issued by a bank or insurer. If the contractor defaults and the client establishes that contractual obligations were not met, the bond provider may pay an agreed amount. Bonds are often around 10% of the contract value. The funds may help cover losses or appoint a replacement contractor, but a bond does not itself complete the project or guarantee automatic payment.
• Parent-company guarantee: The contractor’s parent company promises to support delivery if its subsidiary cannot perform. Depending on the terms, the parent may provide financial support or step in to complete the work. The guarantee’s value depends on the parent company’s ability to meet its commitment.

Business Considerations

• Match protection to project risk and counterparties. The appropriate choice depends on the project and the parties’ circumstances.
• Assess the provider’s strength. Consider the financial reliability of the bank or insurer issuing a bond, and the solvency of the parent company providing a guarantee.
• Consider layered protection. Some projects use both instruments to combine the possibility of financial recovery with continued delivery.
• Draft for the intended outcome. Tailor the wording carefully to the project; poorly drafted terms may restrict recovery or create loopholes.
• Plan for continuity. Security can help a client fund a retender or appoint a replacement contractor after a failure.

Example

A council’s leisure-centre contractor becomes insolvent midway through construction. Without security, the council may face substantial retendering and completion costs. A performance bond could provide funds to offset the impact, while a parent-company guarantee could potentially enable the parent to step in and complete the work.

Presenter/source: Blackstone Solicitors channel.