How to Bonds Work?
A bond is a contract which allows the recipient (the employer) to bring a claim against the bondsman (a bank or insurance company) if a ‘trigger event’ occurs during the construction project. They often expire at practical completion of the works and are limited to claims up to 10% of the contract price.
Getting Paid Under Bonds
The UK construction industry has a long and rather unhappy experience with performance bonds. These bonds are conditional bonds – the condition being that the employer has to prove:
(a) the contractor is in breach or has committed a listed default, and
(b) the amount of its loss resulting from that breach/default.
Getting paid under a bond requires the employer to bring a claim (jargon ‘make a call’) which follows the correct procedure set out in the bond as well as providing sufficient evidence to the bondsman of both the trigger event and the losses arising from that event.
Once all the relevant evidence has been provided, the bondsman may agree to pay the amounts claimed or offer some other settlement.
What is the Insolvency Myth?
Over the years, a myth has built up that every performance bond MUST list insolvency as an ‘act of default’ or one of the trigger events to allow the employer to bring a claim under the bond, when the contractor becomes insolvent.
This is not true.
Why Did the Myth Arise?
The myth arose out of the Perar case* despite commentators at the time pointing out this error of interpretation.
In this case, a claim was brought against the bondsman following the insolvency of the contractor. The employer made two errors in bringing that claim.
Firstly, because of the nature of the insolvency and the construction contract, there was no default linked to the actual insolvency. So the claim was invalid at the time it was made. This should not have prevented a successful claim.
Secondly, the employer should only have brought a claim after it had worked out what its losses were from the insolvency. This can only be calculated once the works have been completed by a replacement contractor. The claim was too early!
Why Did the Myth Persist?
The myth continues partly due to lazy drafting or bond users not really understanding the law.
So shortly after the case, bonds started to expressly state that insolvency was a trigger event. This became common drafting practice, without anybody ever stopping to think if it was really necessary.
What is the Claim on Insolvency?
Once the contractor is insolvent, the employer is entitled to end (determine) the contractor’s employment. It can complete the works and claim from the insolvent contractor the employer’s additional costs of completing those works. Unsurprisingly, insolvent contractors find it impossible to pay the employer’s demand for these additional costs.
The contractor’s failure to pay this demand, is a breach of the contract, a default and a trigger event under the bond. It is this breach, the non-payment once the works are complete, which should form the basis of the employer’s claim under the bond.
What Should You Do?
As employer: you should read and understand the limits of your bond. They are not ready cash and have plenty of escape options for the bondsman. Here are some issues to look out for:
- does the definition of ‘default’ in the bond cover acts and omissions?
- does the contract allow you to claim your additional costs of completion following any contractor insolvency event?
- does the bond require you to ‘ascertain your damages’ under the contract? if so, you won’t get paid until after completion of the rest of the works;
- does the bond require you to notify the bondsman of all defaults? If so, make sure you do – even those which are temporary or which you don’t intend to make a claim based on (strict procedures still have to be complied with).
If you want a cash fund to tide you through this period, use the retention fund (if it’s not held on trust) or bring a claim on a retention bond, enter discussions with any parent company who has provided a guarantee, and remember that you are paying in arrears.
But most of read and understand your bonds: they’re not the panacea they’re cracked up to be!
*Perar v General Surety & Guarantee Co Ltd (1994) 66 BLR 72