The construction industry is capital-intensive. Contractors have to invest massive amounts of money in projects. The risks are extensive too as non-fulfillment if contracts can cause loss of money and reputation. Therefore, contractors have to look for ways to cover these risks and save themselves from losses. There are various measures devised for this purpose. Bank guarantees and performance bonds are two such measures. These two are different concepts and the contractor must comprehend their differences to make an appropriate choice:
Type of contract
A bank guarantee is an undertaking that a bank or similar financial institution provides to a beneficiary. It is normally given on demand and specifies a maximum sum of money that the bank guarantees to pay. The principal (contractor) has to provide a financial security to the bank as a consideration for the guarantee. The value of this security has to be equal to the maximum guaranteed sum. A contractor’s bank guarantee may be in the form of a performance bond. The bond will generally have a clause allowing the bank to pay the bond even in case of non completion of the contract. However, the amount given by the bank will be payable to it by the contractor.
Unlike bank guarantee, a performance bond involves three parties- the contractor, the surety and the obligee. The surety (usually an insurance company) guarantees the completion of contract to the project owner on the behalf of the contractor. The bond protects the project owner from the risk of non performance in the event of default. In such a case, the responsibility of project completion falls on the surety.
A bank guarantee will almost invariably require the contractor to provide an indemnity. It could be in the form of a personal guarantee from the project owner and even hard security from any party that can supply it. The assets provides as a security are pledged with the bank for securing bank bonds.
Most of the time, performance bonds do not require a security. They are usually given on the basis of the contractor’s financial strength, credit rating, experience and standing in the market.
The cost of a bank guarantee is variable during the bond period. The banks fees are generally payable at intervals of 3-6 months. The cost also includes administration fees.
Performance bond, on the other hand, required the contractor to pay an application fee and then the premium amount in case the application is approved. The cost varies from 1% to 3% of the bond value and is to be paid one-time as a lump sum amount.
In case of non-fulfillment of the contract, the bank will have to pay out the guarantee value though the contractor will have to reimburse it later.
The project owner can claim the losses from the surety in the event of contract default. The surety will either have to get the project completed by financing the original contractor or arranging a new one. Alternatively, they may pay the bond amount.
A contractor can study these differences to look for a surety arrangement that works for him. They can also consult experts for professional advice. Learn more at Swiftbonds to get the right kind of bond for your project.