The name’s Bond…Construction Bond

Anna Wood summarises the different types of bonds and how to avoid making a Spectre of yourself (groan).

Bonds are a commonplace way within the construction industry to protect the employer in the event of contractor default. Despite this, the parties often make mistakes in their drafting and operation, usually due to a misunderstanding about the way the Courts interpret these documents. The two most common forms of bonds are “on demand” and “performance” bonds, the difference being that the former type does not require the employer to demonstrate contractor breach before claiming.

Whilst performance bonds are far more popular in the UK, I will run through the key points on “on demand” bonds since this is where mistakes are commonly made.  For those interested, case references appear in the footnotes.

1. Regardless of what is stated on the face of the bond, it is important to note that unless it has been issued by a bank, the Courts will generally not find that a bond is "on demand". [1]
2. If there is reference to guarantee the sums ‘due’, this implies that proof of the sums being due is required, thus making the bond a ‘performance’ bond. [2]
3. The operation of a bond is critical. Where a bond requires that any demand on it must be accompanied by specific declarations, a failure to do so will render the claim invalid. [3]
4. The Courts will not allow the employer to buy itself time for a claim by failing to issue certificates (where the issue of certificates would be a trigger for ending the right to claim under the bond).[4]

Turning now to “conditional” or “performance” bonds, it is worth noting various pitfalls:

1. Despite the changes brought about by the Construction Act[5], contracts of guarantee do still have to be in writing. [6]
2. A performance bond is null and void if proof of the default cannot be established. [7]
3. The Courts have frequently had to consider claims following automatic termination of a contract upon the contractor’s insolvency. The general position is that unless the insolvency itself is a breach of contract, the contractor’s insolvency does not trigger a right to claim. [8]

Now, you may be wondering, why it is worth noting any of this when you can simply use the Association of British Insurers Model Form of Guarantee Bond (“the ABI Bond”)? The ABI Bond is thankfully, widely accepted by many employers. However, bank funders often like to see specific wording in bonds which is not contained in the ABI Bond. Alternatively, they may want an “on demand” bond, which the ABI Bond is not. 

What is clearly important in any event is that both parties must be clear on what is required and what is provided; the contractor does not want to pay more for a better bond than is required, and the employer does not want to find all too late that the bond does not do what was intended. 

These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.