The name's Bond, Performance Bond
Just like the subject of the awful pun with which I ill-advisedly decided to start this article, the performance bond has undergone a number of changes over the years and it is fair to say that the world has changed around it to the point where people are beginning to question its usefulness.
Against a background of market uncertainty due to Brexit and now the very real possibility of a post-coronavirus recession, many contractors are experiencing increasing difficulties in obtaining performance bonds for both private and public sector projects. As is often the case, smaller and mid-sized contractors are hardest hit, with construction firms indicating that sureties and banks are reluctant to provide bonds to any but the strongest of contracting companies.
This in turn has led to the cost of bonds increasing; a cost which is usually ultimately borne by the Employer. Where bonds are still available, we are seeing more and more banks and sureties seeking to further dilute the terms of the bonds they are offering; leading many Employers to question whether they still provide value for money. It is a difficult dilemma for Employers – project risk increasing whilst project security instruments are becoming less valuable.
It had become rare in the UK construction bond market to be able to procure a true "on demand" performance bond, that is, a bond that could be called upon by service of a written demand by the Employer without the need to substantiate its losses. However, on-demand bonds are still common in some sectors; in international construction projects for example; operating so that in the event of breach by the contractor of its obligations, or in the event that the contractor suffered an event of insolvency, the bank or surety providing the bond would pay damages up to the agreed bond limit in order to provide immediate access to funds to keep the project going.
The "immediate access to funds" point is a crucial commercial driver for Employers and can make the difference between the project continuing or failing. If the Employer has to get involved in a long drawn out process of establishing contractor breach and proving its losses before it can receive a pay-out under the bond, then this delays the process of engaging and paying others to complete the works; threatening viability of the project as a whole. In the UK, the market's compromise solution to this was the greater use of "default bonds" making use of the fast-track adjudication process introduced by the Housing Grants, Construction and Regeneration Act; the idea being that, whilst bonds were not on-demand, at least the parties might be able to refer their claim to an independent authority which would be expected to issue its decision within the 28-day period from the start of the referral.
Whilst the unamended Association of British Insurers (ABI) standard form of guarantee bond does not expressly refer to adjudication (an amendment that we usually seek to include for clarity), a recent decision in the Technology and Construction Court in the case of Yuanda v Multiplex and ANZ Banking Group has now held that the requirement that the Employer's losses were "established and ascertained", the wording that appears in the ABI bond, would be met by the obtaining of an adjudicator's award. However, it is a common misconception in the industry that adjudication automatically means a quick resolution and crucial time can be lost if monies cannot be procured quickly to fund the development.
In the UK, the "on-demand" form of bond has not completely disappeared but now is only commonly available to secure advance payments, payments for offsite materials and retentions (in lieu of a cash retention, the concept of which itself is under fire). The JCT forms of Advance Payment Bond, Off-Site Materials Bond and Retention Bond, for example, still contain the "on-demand" wording: "the Employer shall in making any demand provide to the Surety a completed notice of demand in the form of the Schedule attached hereto which shall be accepted as conclusive evidence for all purposes under this Bond… the Surety shall [within 5 Business Days after receiving the demand] pay to the Employer the sum so demanded".
However, recently, we have seen a reluctance from sureties to offer anything other than "default bonds" even in these circumstance; with requests to amend this wording, or even to offer a completely different form of bond which is more akin to a default performance bond.
It is too early to say whether the increased premiums and dilution of wording will ultimately lead Employers to abandon completely the use of performance bonds. It is clear that properly used they are an important tool in project recovery. There have been calls for the Government to step in to underwrite project bonding requirements, by setting up an organisation similar to the export credit agency. This seems unlikely given the Government's emphasis on non-interventionist measures to encourage the construction industry to get back up and running, but in an industry that is already questioning the use of cash retentions and facing increasing challenges to the availability of insurance, the options for performance security are becoming fewer and fewer. Many Employers are asking themselves how they can adequately protect their projects in these increasingly uncertain times.