Did you know that performance bonds date all the way back to 2,750 BC? One might be surprised by the longevity of the performance bond, but this underlines its commercial usefulness, particularly in the context of building and construction. Although it may seem complicated and technical to most people at first blush, the performance bond is in fact an essential tool. Underneath the jargon, it is ultimately a tool used by owners in the building and construction industry (hereinafter referred to as “client”) to protect themselves against contractors who do not perform their contractual obligations under a construction contract.
What is the purpose of a performance bond?
In the building and construction industry, a performance bond is used to provide security in various situations. Commonly, these performance bonds are used to provide security in respect of a contractor’s performance during the contract period. Thus, a performance bond protects the client from the risk of a contractor failing to fulfill its contractual obligations to the client. In other words, the performance bond is a guarantee to the contractor that the project will be satisfactorily completed.
How does a performance bond work?
Performance bonds are unlike retention sum. The latter involves the client retaining a proportion of a progress payment, as security for the contractor’s performance of the its obligations under the Construction contract. This may not be desirable always as it affects the contractor’s cash flow. Thus, a contractor may seek to provide alternate forms of security such as a performance bond. A contractor can procure a performance bond from the bank or an insurance company (“bondsman”) in favour of the owner-client. Having a reliable and financially able third party guarantees the payment under the performance bond and thus protects the client not just from the risk of the contractor not fulfilling its contractual obligations, but also from the risk that the contractor may not be able to compensate the client for their non-compliance or breaches of their contractual obligations.
What are some types of performance bonds?
There are two main types of performance bonds.
- On demand: this means that the bond, or the amount payable under the performance bond, is payable to the client upon the client requesting such payment. There is no requirement to show that the contractor is in breach of its obligations.
- Conditional: this means that the bond is payable only after the occurrence of a prescribed event. Usually, this is triggered by a default committed by the Contractor such as a delay by the Contractor to complete the works by a stipulated period or a failure to rectify defects after the completion of works.
How may a contractor resist performance bonds?
An on-demand bond places a heavy financial risk on the contractor. A contractor must take the risk of the unconditional wording of the on-demand bonds.
Thus, calls on performance bonds, if abused, may affect the contractor from defending its rights when confronted with a dispute on the underlying construction contract. contractors must note that the bond operates independently from the underlying contract (ie: the Construction Contract). Payment of the sum called does not extinguish the liability between parties in the underlying contract. This means that parties are able to commence proceedings in Court or Arbitration to resolve issues that remain unresolved pursuant to the underlying contract.
In Singapore, a contractor can only resist a call on the performance bond on the grounds of fraud or unconscionability. This is a departure from the position in the UK which only provides for fraud as a ground to resist a call on the performance bond.
The Singapore High Court case of Raymond Construction Pte Ltd v Low Yang Tong and AGF Insurance (Singapore) Pte Ltd (1996) had stated that unconscionability ‘involves unfairness, as distinct from dishonesty or fraud, or conduct of a kind so reprehensible or lacking in good faith that a court of conscience would either restrain the party or refuse to assist the party. Mere breaches of contract by the party in question … would not by themselves be unconscionable’.
Contractors frequently cite unconscionability when attempting to resist a call on the performance bond. It must be noted that as there is some degree of uncertainty with the definition of unconscionability, each case would turn on its facts. Nevertheless, it is not easy for contractors to reach the high threshold of unconscionability required to resist a call on the performance bond.
What is the period of a performance bond?
The period of a performance bond depends on the terms of each bond itself. However, the client is better protected if the performance bond lasts until the end of the defects liability period when the final certificate is issued. This is to ensure that the client is protected from any possible default by the contractor, especially those that may only arise or be revealed after a period of time.
What is the value of a performance bond?
Performance bonds may represent around 5 to 10% of the contract value. However, the amount may also vary from project to project. Factors such as the perceived financial strength of the contractor, the capacity of the contractor, the volume of the project and the degree of difficulty of the project. Ultimately, in line with the purpose of the performance bond, the amount should be enough to enable the client to overcome difficulties caused by the contractor’s default, particularly, the need to find another contractor to complete the project.
Have any questions about performance bonds ?
If you have any questions regarding performance bonds, you can get a Quick Consult with Srijit Jeshua or with other lawyers. With Quick Consult, from a transparent, flat fee of S$49, the lawyers will call you back on the phone within 1-2 days to answer your questions and give you legal advice.
This article is written by Srijit Jeshua from Netto & Magin LLC and edited by Rishika Pundrik of Asia Law Network.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.