Are bonds the ointment for ‘burnt fingers’ from retentions?
If retentions are outlawed, how might a bond system work – as an alternative way of ensuring contractors complete their obligations on construction projects? Stefan Berry looks at a recent case.
The government recently ran a consultation on cash retentions in construction contracts and, anecdotal evidence suggests, there are plenty in the industry with fire in their bellies for reform. Judging by the research commissioned by the government in advance of the consultation, construction has good reason to be hot and bothered by retentions. Key issues identified included:
- A large proportion of contractors who use retentions have had their fingers burnt, losing retentions monies due to insolvency. This is of course particularly pertinent in the wake of Carillion’s collapse.
- Payment of retentions are often conditional on performance of obligations under another contract, typically in subcontracts, linking the retentions to the main contract; and
- Late and non-payment of retentions are significant issues for contractors, with this impacting approximately 70% of respondents to surveys.
As a result, the indication from the consultation paper is that the government’s response will be somewhere between promoting alternatives to retentions and making the practice illegal completely.
So, what are the alternatives to retentions – a practice which is over 100 years old, and is intended to provide security for defects and incentivising swift progress? One option put forward is a bonds system.
This could be retention bonds or performance bonds – both carry advantages and disadvantages, and potentially increase costs for suppliers. However, minimal consideration has been given to the potential legal implications.
“The sureties that issue bonds are unlikely to simply pay out upon the first request; some strong persuasion is generally necessary.”
Retentions are a relatively simple process. A percentage of the contract sum is withheld with half to be repaid on completion of the works and the other half when defects have been made good, generally as part of the final payment. Retention clauses in the standard form contracts are relatively clear and well understood.
There are also standard terms and forms for bonds, including those of the Association of British Insurers (ABI) and the JCT. However, bonds are less well understood than retentions, even by the lawyers who draft and amend their terms.
As with retentions, difficulty arises with insolvency. An example of this was the recent case of Ziggurat (Claremont Place) v HCC International Insurance Company .
The Ziggurat case concerned the ABI model form of guarantee bond, with a clause added. It aimed to ensure that damages payable under the bond included any sums or debts payable following the insolvency of the contract.
During the project, the contractor stopped work, which the client responded to with a notice of default followed by a notice of termination. Following the notice of termination, the contractor entered into a creditors’ voluntary agreement (CVA). The client then appointed another contractor to complete the works, and attempted to recover damages and make a claim under the bond.
Hindered and confused
But the court decided that the bond did respond to the insolvency of the contract. The impression given by the judgement is that the amendment to the bond hindered and confused matters, and that the same conclusion might have been reached more efficiently without it.
The project had used a JCT contract and following completion of the works, a balance had become due from the contractor, accounting for loss and damage suffered under the provisions dealing with termination. Non-payment of this balance by the contractor was a breach that the bond would ordinarily respond to, had there been no amendment.
Another notable point is that the client had to pursue a case against the bond provider. This is a particularly important point. A bond provides the right to claim for the money, which is of course not the same as holding the money in an account, as with retentions.
The sureties that issue bonds are unlikely to simply pay out upon the first request; some strong persuasion is generally necessary.
From the perspective of both main contractors and subcontractors, bonds present another set of terms to be negotiated, particularly where the model form has been amended – and it is not always certain that the surety will provide a bond on those terms.
So, while changes to the current retentions practice seem likely – the construction industry needs to think very carefully before using bonds as an alternative.
Stefan Berry is a junior associate at Quigg Golden