Why have bonds become so important to the UK construction market?

In times of prolonged economic uncertainty, the demand for Guarantee Bonds has grown significantly within the UK construction industry. Due to the financial impact of recent global events, many firms are contractually required to have a guarantee bond in place to protect their Employer in the event of the Contractor’s default on their contractual obligations or insolvency.

What is a bond?

Guarantee bonds are a type of financial security that covers direct loss or damage suffered by an Employer because of a contractual default. Performance bonds are amongst the most issued bonds in the construction market. They typically cover damages up to 10% of the overall contract value, although they occasionally offer 15% and less commonly 20% of the contract value in certain circumstances.

Ben Milan, Surety Manager, Kerry London, said, “Bonds are not a general insurance product and can be reasonably complex affairs, so it’s important to use a specialist team with experience. This ensures that Contractors are aware of the obligations of the product they are buying and are advised accordingly.”

What other types of bonds are used in the construction market?

Retention Bonds

A Retention Bond is a financial guarantee that allows the Employer to release the retentions held on a contract to the Contractor. These bonds allow the retentions released to enter the Contractor’s cash flow and be used as working capital. The Employer typically holds between 2.5% and 5% of the overall construction contract value for up to 24 months, sometimes longer. This period is called the Defects Liability Period. Retention bonds effectively guarantee that the Contractor will rectify any defects after Practical Completion (PC) has been achieved. The Retention Bond would usually include a fixed date expiry, around 12-24 months after PC, or expire upon the date of issue of the certificate of ‘Making Good Defects.’

Advance Payment Bonds 

An Employer will typically require Advance Payment bonds if a Contractor requests an advance payment to cover the costs of securing materials ahead of work starting. These bonds protect the Employer if the Contractor fails to fulfil its contractual obligations, for example, if the Contractor becomes insolvent. These bonds benefit the Contractor as they help to maintain a healthy cash flow as they aren’t faced with the initial materials outlay before they start work. An Advance Payment bond would typically expire upon the delivery of materials to the site as certified by the Employer or upon the date of issue of the Practical Completion Certificate.

National House Building Council (“NHBC”) Bonds 

NHBC bonds guarantee against the failure of the Contractor/Developer to maintain properties within the 10-year post-construction period covered by the NHBC building warranty.

Deferred Consideration Bonds  

A landowner may be willing to sell land to a house builder or property developer on deferred payment terms. A Deferred Consideration Bond can be arranged to guarantee payment of instalments if the house builder or developer defaults. This method of bonding frees up the financial recourses of the house builder or developer and gives peace of mind to the seller of the land.

Section Bonds

Section bonds, often referred to as Highways and Sewer bonds may be required to secure the cost of completing the necessary infrastructure works for a Local Authority or Council. These bonds guarantee that the relevant infrastructure works will be completed to the appropriate standard required by the local Highways or Water Industry. Section bonds will usually expire once the “Taking Over Certificate” is issued and the relevant authority has taken over the roads/sewers.

Other bonds that Kerry London Limited can arrange include, but are not limited to:

• Warranty bonds
• Customs bonds
• Environmental bonds
• Pension bonds
• Bid bonds

Kerry London is authorised and regulated by the Financial Conduct Authority. The company is a leading UK independent and Lloyd’s accredited broker, which means that we work with a wide range of niche and major insurers.

This note is not intended to give legal or financial advice, and, accordingly, it should not be relied upon for such or regarded as a comprehensive statement of the law and/or market practice in this area. In preparing this note, we have relied on information sourced from third parties, and we make no claims as to the completeness or accuracy of the information contained herein. You should not act upon information in this bulletin nor determine not to act without first seeking specific legal and/or specialist advice. We and our officers, employees or agents shall not be responsible for any loss whatsoever arising from the recipient’s reliance upon any information we provide herein and exclude liability for the content to the fullest extent permitted by law.

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