In this article we’re going to explore construction bonds. The different types of bonds available & the purpose they serve throughout a construction project.
So, what is a construction bond?
Put simply, a construction bond provides protection to the client against the non-performance of a contractor.
There are 3 parties involved in a construction bond:
· The client
· The contractor
· And a bondsman/ surety
The bondsman or surety takes responsibility for the contractors’ obligations by signing a bond. The bondsman is then obliged to pay the client upon certain criteria being met.
It should be noted under English Law, there is an important difference between a bond and a guarantee. Some “bonds” commonly used in construction are actually considered “guarantees” under English Law. In a construction context, a “bond” does not require the employer to establish a breach under a building contract to obtain the agreed sum in a bond. However, this is required under a guarantee.
Construction bonds can be split into two categories:
· On-demand bonds (i.e., primary obligations)
· And conditional bonds (i.e., secondary obligations)
With on-demand bonds, the bondsman pays out an amount set out in a bond immediately without needing to establish the contractor’s liability (unless the demand is fraudulent). On-demand bonds are more common in international projects but are seldom used in UK projects.
Conditional bonds are only paid out provided certain contractual conditions have been fulfilled. Usually, insolvency or breach of contract by a contractor.
As you can see “on-demand bonds” are more akin to what English Law defines as a “Bond” & “conditional bonds” are more akin to what English Law defines as a “Guarantee” However, for the purpose of this article & to keep in line with commonly used terminology, we will use both bond & guarantee synonymously.
So, what are the different types of bonds available?
In this article we’re going to look at 7 different types of construction bonds:
1. Performance bond
2. Tender bond or bid bond
3. Retention bond
4. Off-site materials bond
5. Advanced payment bond
6. Defects liability bond
7. And Adjudication bond
A performance bond can be seen as an insurance, protecting the client against the contractor failing to fulfil contract obligations. Usually set at 10%, this type of bond ensures the client has the funds to overcome the issues caused by non-performance of a contractor. For example, the cost to find a new contractor to complete the works.
Tender Bond (or Bid Bond):
The purpose of a tender bond is to discourage a bidder from abusing the bidding process. The tender bond is submitted with a tender and ensures the contractors commitment to start a project. The downside to this bond is it may discourage smaller companies from tendering for the works,
A retention bond is a percentage (usually 5%) of the amount certified, due to a contractor on an interim certificate that is retained by the client. The purpose is to create a financial incentive for the contractor to complete the work successfully, and provides as a protection to the project stakeholders in the event of problems. i.e., the retained money can be used as insulation for that risk.
Advanced Payment Bond
Advanced payment bond is used when… you guessed it, advanced payment is made for constructions goods or services. Sometimes in construction, advanced payment is made when contractor’s incur significant start-up costs for providing goods or service. This bond protects the employer in case something goes wrong with the execution of service or goods received.
Off-site Materials Bond
This is like the advanced payment bond. Sometimes the contractor pays for materials before it is delivered to site. This bond is often used to protect the programme against delays.
Defects Liability Bond
This bond is tied to the defect liability period usually lasting 12 months after practical completion. This bond ensures the contractor continues to provide a service correcting any defects apparent after completion of works.
Adjudication is process used for a swift dispute resolution. Adjudication bonds are conditional bonds which require the bondsman to pay out based on an adjudicator’s decision.
Why not watch our video on this subject?