In the current economic climate, contractor default is even more prevalent in the construction and engineering industries. Therefore, Registered Social Landlords (RSLs) should always look to protect their position when entering into construction contracts by taking active steps to guard against the risk of potential insolvency of contractors.
This is usually done by the contractor entering into a parent company guarantee or a performance bond which acts as security for losses sustained by the developer should the contractor fail to perform its obligations under the construction contract.
If faced with a choice between a parent company guarantee and a performance bond, RSLs should consider what option is the most appropriate for them:
Parent Company Guarantees
Typically a parent company, or other group company, of the contractor grants a guarantee in favour of the RSL. This means that the guarantor guarantees the performance of the contractor under the terms of the construction contract. If the contractor fails to perform their obligations, the guarantor will effectively step in to complete the work.
There is no set form of parent company guarantee, however, a well drafted guarantee will provide that the guarantor completes all of the contractor’s obligations under the construction contract. A well drafted guarantee will also provide the RSL with the ability to recover all losses and expenses which they incur, or will incur, from the guarantor as a result of the contractor’s breach or insolvency. Parent company guarantees are usually provided free of charge by the contractor.
Parent company guarantees are not free of risk. If an insolvency event were to affect the entire group, the guarantee would be rendered worthless and the RSL would not have any protection under the parent company guarantee.
A performance bond is an insurance policy taken out by the contractor – this can be at either the contractor’s or the RSL’s expense. The bond is provided by a third party (usually an insurance company or a bank) and if the contractor should fail to perform the duties under the contract the RSL may recover the losses from the insurer. Performance bonds are usually limited in value to 10% of the total contract sum. However, RSLs will usually have to bear the cost of a performance bond and they should keep this in mind when opting to use this method.
During the procurement process, RSLs may wish to state that either a parent company guarantee or a performance bond will be required. This will allow RSLs to assess what the best method would be when they have appointed a contractor.
If you would like further information or advice on either Parent Company Guarantees or Performance Bonds please don’t hesitate to contact us.