How do performance bonds and parent company guarantees work? Journal

How do performance bonds and parent
company guarantees work?
Reproduced by kind permission of RICS Construction
February 2009
Two of the most common forms of security used by employers to provide protection in the event
of a contractor's default are Performance Bonds (PBs) and Parent Company Guarantees
PBs are typically provided by banks or insurance companies. They give the employer a
guarantee of payment up to a stated amount of money should they suffer a loss as a result of
the contractor's breach of his contractual obligations (the industry standard is 10 per cent of the
initial contract sum).
PCGs are provided by either the contractor's immediate parent or other holding company and
operate as a guarantee to ensure a contract is properly performed and completed. In the event
of a contractor default, the parent is obliged to remedy the breach. If the contractor is no longer
able or willing to continue with the works, the parent will be obliged to meet all of the
contractor's obligations and complete the works to the standard specified in the terms of the
original contract.
PBs and PCGs provide different remedies, types and levels of protection to the employer for
contractor default. If both forms of security are available, the factors outlined below should be
considered to assess which remedy is the most appropriate for the development in question.
A PB gives the comfort of being a payment guarantee from an independent third party, whereas
the strength of a PCG is directly related to the financial covenant of the parent. In assessing the
adequacy of the PCG, an employer should be satisfied with the identity of the parent and
similarly should insist that any PB be from a reputable guarantor.
A contractor will normally charge a premium for the provision of a PB whereas a PCG should
not have a cost implication for the contractor (with the exception of administration fees). Of
course, a PCG will not be available if the contractor has no parent and may not be desirable if
the proposed parent does not have a good financial covenant.
A PB does not guarantee completion of the project, just recovery of financial loss up to a stated
maximum amount. A PCG does guarantee the continuing performance of the contract, but is of
little benefit if the parent is equally unable to perform the contract (e.g. group insolvency).
Typically, PBs only operate for the period in which the contractor has immediate obligations to
carry out the works in question and expires at either practical completion or the end of the 12
month rectification period. However, a PCG will often be co-extensive with the maximum
duration of the liability the contractor has under the underlying contract (i.e. six or 12 years
depending on whether the contract has been executed under hand or as a deed) and covers the
contractor's liability for the remedying of latent defects.
An event of insolvency alone will not necessarily give rise to payment entitlement under a
standard unamended ABI form of PB, as this may be treated as an event terminating the main
contract. Equally, the terms of each PCG will need to be reviewed to ensure they cover an
event of insolvency.
It is notoriously difficult to obtain payment under a PB. A bondsman would ordinarily require the
breach of contract to be upheld either in adjudication or court proceedings and the employer
would be required to provide clear evidence of the loss it has suffered as a result of the
contractor's breach.
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