Jonathan Seddon: Why are developers still being short changed on performance bonds?
Partner and head of construction law at Morton Fraser, Jonathan Seddon, returns to the subject of the use of performance bonds in the Scottish construction sector.
I wrote an article for Scottish Construction in July 2019 highlighting that because of the wording of the ABI Model Form of Guarantee Bond, and the manner in which certain sureties (bond issuers) choose to interpret that wording, some developers whose contractors had gone bust were being told that they would have to wait until after the Final Account had been agreed to receive the bond amount. Or, the developers were being told, you can have the money now, but it will be far less than the 10% of the Contract Sum that you were expecting.
Since then, nothing has really changed.
As I said in the 2019 article, the ABI form of bond has been a huge success. The ABI has successfully introduced an industry-standard model form of guarantee, which has largely replaced the countless different styles of bond that were floating around pre-1995.
So what’s the problem?
The issue with the ABI wording relates to the obligation on the surety to pay any damages sustained by the developer “as established and ascertained pursuant to and in accordance with the provisions of or by reference to the Contract and taking into account all sums due or to become due to the Contractor”.
But if you are the developer and your contractor goes bust, you call on the bond and the surety says that it is only once the Final Account (or equivalent) has been agreed that the exact amount of damages payable can be “established and ascertained”, and so the surety won’t be paying any money out until after the Final Account is agreed, what happens then?
If you are a larger developer, with multiple projects on the go at any one time, it is more likely that you may be able to ride this out.
But if you are a smaller developer and this is your only live project, the impact will be far more painful. So what happens is this:
You need the money now to re-tender the works and keep the project going. You can’t wait until after the Final Account. In fact, if you don’t resolve the problem soon, there might never be a Final Account. The surety recognises this but can’t (or won’t) pay you the full 10% of the Contract Sum in advance of damages being properly “established and ascertained”, so as a gesture the surety offers to pay 80%. You need the money, so you reluctantly accept, probably making up the 20% shortfall from your own funds and diluting any profit left on the project.
That, I would suggest, does not seem fair.
Now the counter-argument is obviously that nobody issues an “on demand” bond anymore. Bonds are only ever issued to cover actual damages and/or losses. And the amount of those damages or losses can only be known once all set-offs and counterclaims have been taken into account. It is difficult to argue that this proposition is unfair.
But do you realise, as a developer, and having paid for the protection of a bond, that you may be unlikely to be entitled to that 10% of the Contract Sum until much further down the line? If you do realise that, and you have factored that into your project planning, then fine. Or you may have agreed alternative bond wording with the contractor and surety, so you may have covered the issue off already. That is the best-case scenario. But if you weren’t aware of this issue, so haven’t factored it into your plans, and haven’t covered it off in the contractual wording, you could be in for a nasty surprise.