Like Bank Guarantees, Performance Bonds are a financial instrument, rather than a financial product, and is a three-party contract.
Performance Bonds are part of the broader Surety Bond range and provide protection for the principal/project owner against the default or non-performance of the contractor for a particular contract.
The Performance Bond is issued by an insurer (Party 1) in favour of the principal/project owner (Party 2) undertaking that part or all of the bond amount will be paid to the principal/project owner in the event the nominated contractor (Party 3) does not deliver in accordance with the terms and conditions of the Performance Contract.
Similar to a bank guarantee, the contractor requests that the Performance Bond is issued in favour of the principal/project owner. Whilst the contractor pays for the Performance Bond, the principal/project owner is the beneficiary in the event that the Performance Bond is called.
Performance Bonds carry the same wording as a bank guarantee and follow the Australian Standards template (such as AS2124, which requires an unconditional and on demand undertaking) and carry exactly the same obligations at law as a bank guarantee. Insurers are not able to call their offering a bank guarantee, as they are not a registered bank. Otherwise the offerings are identical.
Like bank guarantees, payment must be made by the insurer on demand, unless the bond specifically states otherwise and without any assessment as to the amount to be paid. The only assessment occurring is to ensure the claim is made in terms of the Performance Bond itself - a process identical to the payment of a bank guarantee.
Surety Bonds, which include Performance Bonds, have been part of the Australian market for over 60 years and are widely accepted by the private sector and Commonwealth, State and Local Government Authorities and Agencies.
Some self-interested parties push the line that Surety Bonds issued by insurers are not as secure as bank guarantees. The recent global financial crisis pretty well pushes that misconception out of the equation.
The reality is that the major international insurers, which include Lloyds of London, have credit ratings equal or greater than most global financial institutions.
One key aspect often overlooked is that Surety Bonds fall outside the Bankruptcy Act in Australia, therefore, in the event of the liquidation of a contractor, the principal/project owners aren’t impacted as their call is against the insurer and not as an unsecured creditor as is the case with a bank guarantee.
Performance Bonds are an integral part of the various types of contracts awarded, providing protection to the principal/project owner if the contractor fails to perform to contract specifications.
In difference to bank guarantees and from a principal’s/property owner’s perspective, there’s the added advantage that the contractor's performance ability has been independently assessed by the insurer who holds valuable knowledge about the contractor’s involvement in other projects and their performance and claim’s history.
Before agreeing to issue a Performance Bond, a comprehensive review of the contractor's performance is undertaken, which includes an assessment of the contractor's financial status, management strength and past performance record with respect to prior contracts.
From a contractor’s perspective, their bank credit facilities are totally or partially freed of bank guarantees, thus delivering greater financial leverage from their asset base and freeing up working capital and cash flow. This allows for increased growth opportunities.
Typically, standard contracts require the contractor to offer some form of surety to the principal/project owner which is 2.5% to 15% of the total contract value. The percentage may be tiered depending on the stages and timeframe of the relevant project.
Typically, contractors are involved with an ongoing number of existing and new projects, so we establish a ‘multi-bond facility’. Not dissimilar to an approved line of credit with a financial institution that can be drawn down/used/reused as required.
If a project is of sufficient size, we will look at ‘one-off’ risks.
Because of the assessment work involved, plus upfront costs to undertake various statutory checks and searches, a non-refundable application fee of $600+GST applies.
The pricing of Performance Bonds depends upon the risk profile of the contractor; the Performance Bond amount required; the duration of the Performance period; and any other relevant information. The determined premium must be paid in full prior to the Performance Bond being released to the nominated party.
This will only occur if the contractor has defaulted or has not performed in accordance with the particular contract.
If the principal/project owner seeks a payout under the
Performance Bond, the insurer will pay the principal/project owner and then
immediately seek recovery of the claimed amount from the contractor.
The recovery is either against the operating entity or the director’s personal guarantees.
Contractors (applicants) must be able to demonstrate that they:
Clear documentary proof of the above, in addition to the require application documents; will ensure that Contract Bond applications are approved in a timely fashion.
Contractors seeking a Supply or Advance Payment Bond facility must meet the following criteria: