Bonds

A bond is a promise (usually by deed) whereby the person giving the promise (the bondsman) promises to pay another person (the employer) a sum of money. The bondsman only becomes obliged to make payment when called on to do so (taken from Keating on Construction Contracts).

While several different types of bond are used in the industry (for example, advance payment bond, retention bond), the 'performance bond' is probably the most commonly used form of bond. Consequently, this section focuses on the performance bond only.

Although the institute providing the bond may be referred to as either a surety or a guarantor or a bondsman, for the purposes of this section we use the latter term only, except where one of the other terms is used in a direct quote.

Whichever form of bond is required, the key issues for the employer are, first, to make sure that, if there is a need to call on the bond, the bondsman has sufficient assets to honour it. Historically, it is for this reason that a bond was provided by a financial institution such as a bank, bondsman or insurance company. (As a consequence of the credit crunch, we might wish to reconsider just how secure a bank, bondsman or insurance company's guarantee might be!) And second, that the bond can release funds to an employer to appoint an alternative contractor at the time when disaster strikes.

Performance bonds

Most employers will request a performance bond from the contractor, who in turn obtains it from a bank or insurance company in favour of the employer. The bank or insurance company usually obtains a counter-indemnity from the contractor or a parent or associated company of the contractor. Performance bonds take 1of 2 forms: either an 'on-demand' bond (which is an indemnity) or a 'default' bond (which is a guarantee).

Both forms of performance bond will provide the same relief to the employer: an agreed sum of money (usually 10% of the contract sum) payable by the bondsman to the employer (either 'on demand' or on 'default' depending on the bond's terms). This is usually payable where the contractor has failed to comply with its obligations to the employer to carry out and complete the works under or in accordance with the building contract.