Performance bonds help to provide clients with the assurance that should things go wrong, work on their project will still be financially viable.
Obligations to provide performance bonds are more common than ever in international construction contracts, with the rising scale and complexity of the such projects requiring clients to carefully manage their exposure to risk. However, in the wake of the Coronavirus pandemic, some construction firms have warned of difficulties in obtaining performance bonds.
Typically representative of 10 – 20% of the value of the contract price, performance bonds act as a 'guarantee' over the performance of a contractor's obligations. Should the contractor default on such obligations, the client will, in theory and subject to the terms of the bond, have a quick and efficient remedy to the contractor's breach by liquidating the bond. The proceeds may then be used by the client in respect of the works.
Whilst the largest independent surety bond brokerage in the UK and Ireland has dismissed industry concerns over a perceived performance bond 'shortage', it is easy to see why many in the sector are anxious. In recent years, we have seen a hardening of the domestic insurance market, with many financial institutions concerned over the potential for Brexit-related project failures, amongst other things. A Coronavirus-related recession is only likely to have added to lenders' growing list of concerns.
A shortfall in the availability of performance bonds could have a dramatic impact upon the fate of many contractors, both domestically and abroad. Given their relative ubiquity amongst construction contracts, many clients now insist that performance bonds are provided as a pre-requisite to a successful tender. With many in the construction industry already suffering from cash-flow problems as a result of the covid-19 pandemic, losing out on further business due to a bond deficit could be more than problematic.
Consequently, some have called for the Government to step-in and provide temporary underwriting services to contractors. Internationally, we have already seen others nations, such as Singapore, take this concept a step further, introducing legislation such as the "COVID-19 (Temporary Measures) Act 2020", which provides for restrictions on when performance bonds can be called upon in applicable construction and supply contracts. Whether a similar approach will be adopted by our domestic Government remains to be seen.
Whilst the full impact that covid-19 has had on the construction surety market is yet to be revealed, the early warning signs are troubling. We hope that in the coming months bond providers will work together with both Government and industry to reach a sensible and commercially practicable solution to any shortfall in coverage.
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