To bond or not to bond, that is the [real] question?

I promise you, whole heartedly, that I was going to write about something else this week. I had in my mind a vision of something exciting and interesting, perhaps about new projects, current market trends or changes in law. Basically, anything other than what I am about to delve into. But with that said, this topic is something which has bothered me for years, and when Construction Enquirer published their article “Clients are being urged to ease bond conditions as contractors struggle to get cover in a tightening market” I felt compelled to share my own thoughts.

Sadly, in the construction industry, the risk of insolvency is a persistent reality which we must deal with on an almost constant basis. And whilst I probably don’t need to justify that statement, as most of you reading will have had your own experiences, in April of this year alone 17.3% of all insolvencies in England and Wales were construction firms (BCIS, Latest construction firm insolvency figures 18/06/2024). A stark number when you consider that construction makes up 6% of economic output. So, taking this kind of statistic into account, is it any wonder that client’s and contractors seek to sure up the risk of undertaking construction works by utilising contractual mechanisms incorporating the likes of bonds and retention? Hardly!

The requirement to provide bonds as part of a construction contract is certainly nothing new, in fact they have been around for decades. But in recent years the prevalence of these securities has increased notably. Not only has this placed pressure on those organisations required to offer them as part of a tender, but now also the insurers providing them. The exit of QBE from the bond market will be a hammer blow to many of its regular customers, in what is already a relatively small market. But it perhaps sends an even stronger message to those client’s seeking to rely on them as part of their risk mitigation strategy. If contractors can’t procure the product, then they are unlikely to meet the tender prequalification requirements.

For a long time now, I’ve harboured an unspoken dislike for the overuse of bonds, as I always felt they were used as an excuse, for clients and their consultant teams, to convince themselves that they could accept the risk of appointing the lowest priced tenderer. After all, with the right bond(s) in place, the majority of the financial risk of insolvency sits squarely with the insurer. Leaving them free to go ahead and appoint any Tom, Dick and Harry they felt like. And whilst I accept that this might be a rather jaded view, the widespread use of ever more complex bonds seems to feed into this narrative. By way of an example, I recently reviewed a contract for a tenderer that contained no less than four forms of security (excluding guarantees). An advance payment bond, a performance bond, a retention bond and to cap it all off good old-fashioned retention as well. Not only did this seem like complete overkill, but more pertinent to my client was the fact that they couldn’t meet the financial criteria to obtain all the bonds from a reputable surety, and nor did they want to. This was mainly down to the fact that the bondsman was asking them to ringfence assets, or cash, equivalent to the value of the bond(s) required, which stretched to hundreds of thousands of pounds.

Now before I start getting too ahead of myself, I am not for a minute suggesting that bonds are a bad thing. In fact, I think with the correct application they can have a positive impact on a tender. For instance, replacing retention with a retention bond that diminishes in value over time can only be a good thing for the supply chain. The client has the security of knowing that they have financial measures in place if the contractor fails to complete the works, and the contractor doesn’t have to suffer the deduction of monies from their monthly valuation. Similarly, having an advanced payment bond in place reduces the client’s risk when it comes to making upfront payments. In turn the contractor then benefits by not having to fund certain elements of the work from their own cashflow.

I am a firm believer in adopting a sensible and proportionate approach to insolvency risk, which must incorporate an element of continuous monitoring throughout the lifecycle of the contract. It is not simply good enough to undertake some initial financial checks prior to awarding a tender, and then forget about it the minute the contract is signed. Risk management, this is after all what we are talking about, is continuous process which should be incorporated as part of the QS or financial team’s remit. With the data available these days it is possible to monitor a contractor’s stability for each month of the project, keeping an eye out for a declining credit score which considers late payments, poor payment behaviours, unexpected changes in directors, late submission of accounts, new CCJs, increasing debt etc. Now I’d be the first to admit that this kind of data is not infallible but combining it with what you hear on the ground, what you read in the press and how they are actually performing the works can be quite a powerful indicator of how things are really going. That’s not to suggest that this kind of good practise can replace bonds, but they are some of this things that a project team can undertake to help get ahead of any potential bad news.

Like anything in construction, everything we do concerns risk. And as we all know good risk management is a continuous process, not just something we do once a month because that’s what the contract says. It involves identifying the risks, making adequate plans and then constantly monitoring progress to ensure those plans are effective at diminishing those risks. To that end, drafting a contract for a new project is no different, as is considering the best way to protect a client from the risk of contractor insolvency. But it is not a one size fits all exercise. Different companies have different risk profiles, and as I explained in the last paragraph it is now possible to establish a reasonably clear picture of a contractors track record via the various sources of data available right at our fingertips. Bonds should be used to bring benefit to the contract, instead of being lined up like a series of guillotines waiting to drop. In some instances, they are going to be needed, but I implore you; take the time to think it through, explore the real risks you are facing, and try to use them as a last resort instead of the first line of defence.

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By, Ben O’Connell

Commercial Director

Vinovius

?www.vinovius.com

References

Construction Enquirer - Clients under spotlight after bond bombshell https://www.constructionenquirer.com/2024/06/20/clients-under-spotlight-after-bond-bombshell/

BCIS - BCIS, Latest construction firm insolvency figures published, 18/06/2024