Get More TLC: #4: There’s no real benefit

This edition looks at another type of tiny little contract… the performance bond. Bonds are often used as a tick-box exercise without providing any real benefit to the parties. So, what’s my beef with them and what can you do about it?

A photograph with a thick red firbe tip pen facing downward over a piece of paper marked CHECKLIST. There is a thick red tick in a box against performance bond.

Bad Timing, Limited Availability, Catastrophic Calls

Let me introduce you to performance bonds. Despite its name, a performance bond doesn’t guarantee performance – the surety promises to pay up to a specific sum for poor performance, provided the employer gives it enough evidence. If you’d like an analogy, think of them as a type of insurance. 

On construction projects, a performance bond allows an employer (or someone paying for goods, works and services) to bring a claim against the surety if the contractor breaches their contract. Typically, claims arise when the contractor is insolvent or the goods, works or services are very defective. 

An image showing the use of a performance bond. There are three entities represented by text boxes stacked in a column: the surety (provider of the bond), the contractor (providing goods, works or services) and the employer (receiving goods, works or services). There is thick black double-headed arrow between the text boxes for the contractor and employer, representing the contract between the contractor and the employer. This is an exchange. There is single-headed curvaceous arrow flowing from the textbox for the surety towards the the textbox for the employer representing the performance bond. For the bond promises only go in one direction. Image by Sarah Fox

Bonds became ubiquitous on construction projects in the 1980s, but they are a poor solution to the employer’s problems when the contractor is in breach. The employer really wants the cash to get someone else to finish the job properly, or another contractor who will quickly step in. 

The issues include:

  • Timing: Whether it is for defects or insolvency, the employer must sort out the problems, pay the extra costs and then see if it can claim them back. Bonds are not ‘ready money’.
  • Limited: Because of the volatility of the global economy, sureties will only offer bonds to a limited range of contractors; even when they do, sureties limit their exposure by requiring ring-fenced monies – increasing the cost of bonds, reducing the contractor’s resources to carry out the project and making it more likely the contractor will become unable to pay its debts (ie insolvent).
  • Calls: The reasons given for not paying out on a claim are legion eg incorrect claim procedure, incorrect timing of claim, failure to prove breach/losses caused by that breach/amount of losses, the contract was amended, failure to notify other minor defaults during the project and so on.

The employer already has lots of security including the retention fund, insurances such as latent defects insurance, and the fact that it pays in arrears. Does it really need more paper?