Review your bond: does it need insolvency?

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. The precise rules for bringing a claim depend on the words of the bond itself.

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:

  • the contractor is in breach or a listed trigger event has occurred, and
  • the amount of its loss resulting from that breach/default.

Getting paid under a bond requires the employer to bring a claim (or ‘make a call’) which both follows the correct procedure set out in the bond and provides sufficient evidence to the bondsman of both the trigger event and the losses arising from that event.

The bond/insolvency myth

Over the years, a myth has built up that every performance bond must list insolvency as well as ‘acts of default’ as one of the trigger events that allow the employer to call the bond.

This is simply not true.

The myth arose out of Perar v General Surety – despite commentators at the time pointing out this error of interpretation. The employer called the bond immediately following the contractor’s insolvency. The employer made two errors in bringing that claim.

  1. because of the specific nature of the insolvency and the terms of the bonded contract, insolvency was not a default. So the claim was invalid at the time it was made.
  2. it should only have brought a claim after it had calculated its losses arising from the insolvency – generally after the works have been completed by a replacement contractor.

Claims following insolvency

Including insolvency as a trigger event is common, without it actually being necessary.

Once the contractor is insolvent, the employer can end (determine) the contractor’s employment and complete the works. It can then claim from the insolvent contractor its additional costs of completing those works. Once the (insolvent) contractor fails to pay those additional costs, it is in breach, which forms the basis of the employer’s call.

What should you do?

As employer: you should read and understand the limits of your bond. Conditional bonds (unlike on demand bonds) are not ready cash and have plenty of escape options for the bondsman. Here are some critical questions to ask:

Q1: does the definition of ‘default’ in the bond cover acts and omissions? [failing to stay solvent is an omission]

Q2: does the contract allow you to claim your additional costs of completion following any contractor insolvency event?

Bonus Q3: does the bond require you to notify the bondsman of all defaults? If so, make sure you do – however small and insignificant.

Read and understand your bonds: they’re not the panacea they’re cracked up to be!

Case: Perar v General Surety & Guarantee Co Ltd (1994) 66 BLR 72

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