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LEIA Seminar 2015: Bonds, Indemnities and Warranties

On 26 March 2015, we were invited to speak at and sit on a Q&A panel session at a Lift and Escalator Industry Association (LEIA) seminar held in Birmingham.

The event – ‘Bonds/Indemnities/Warranties’ – invited members of the lift and escalator industry’s trade association to learn more around the subject of on-demand and performance bonds, third party warranties and indemnities.

From an insurance perspective the seminar looked at the risks insurers were prepared to underwrite as well as insured parties’ expectations and demands.

We were joined by Perry Askew and Paul Rowe of Obelisk Underwriting, two very experienced underwriters who underwrite part of the Robert Gerrard Lift Plan®.

Robert Gerrard has been involved in lift industry insurance for more than 30 years. As the UK’s leading lift insurance broker we have more than 400 clients who are covered by our specialist plan designed specifically to meet the needs of lift engineers, consultants, designers and manufacturers.

The seminar provided a great opportunity to gain insight into industry perception, expectations and demands around bonds, indemnities and warranties.

We thought it would be useful to cover these subjects over a series of blog posts, starting with ‘bonds’.

Bonds Explained

Bonds and guarantees are commonly used to protect a party against non-performance of a contractual obligation. They are widely used in the construction sector and the recent rise in the popularity of ‘On-Demand’ and ‘Performance Bonds’ was one of the items on the seminar’s agenda.

A Performance Bond is a form of security which a contractor will usually provide to an employer. It consists of an undertaking by a third party (the ‘surety’) to make a payment for damages up to a stated amount to the employer in the event of contractual non-performance, due either to failure or insolvency. This payment is usually 10% of the contract sum.

An On-Demand Performance Bond will require the surety to pay out in the event of the employer demanding payment, regardless of whether or not the contractor is in breach. The only circumstances under which the surety can refuse to pay out are if it can be proved the demand was dishonest or fraudulent. This type of bond has traditionally been used for international contracts rather than those based in the UK.

Conditional or On-Default Performance Bonds only require a payout if the contractor breaches their contract. This type of bond is more common in the UK and in many cases the surety is an insurer. Proof must be presented that the contractor has defaulted and that the employer has suffered loss. Premiums are less than for On-Demand bonds.

In general, bonds will usually expire on completion of a project, or 12 months after any defects have been made good, whichever comes latest.

directorys risk and assurance

A contractor pre-qualified by a surety such as a bond will provide a higher level of confidence. This will often mean the contractor has a greater chance of winning a contract.

Who offers surety?

Bonds and guarantees were originally issued mainly by banks, but it has become equally commonplace to find them offered by insurers. The benefit for enterprises in using an insurer as surety rather than their bank is that they can liberate their lines of credit for working capital purposes. Because a bond is issued on the amount of working capital available from the contractor’s bank, on issue the amount is deducted from any borrowing facility that has been put in place. Banks are also more inclined to issue On-Demand bonds which are treated as unpresented letters of credit. For this reason it has become common for contractors to seek surety from insurers or specialist surety providers.

The benefits of bonds

From an employer’s point of view, a contractor pre-qualified by a surety such as a bond will provide a higher level of confidence. This will often mean the contractor has a greater chance of winning a contract.

Other types of bond

There are numerous types of bond, including some that are based on the Performance Bond structure but geared towards specific industry needs, such as a Construction Guarantee Bond.

An Advance Payment Bond guarantees an employer’s upfront payment for goods or services. On a similar principle to this is an Off-Site Materials Bond. This assures payments made for goods held off-site by a contractor ahead of their requirement for a project.

Contractors will often submit a Bid/Tender Bond with a tender to show the employer their ability to commence a contract should it be awarded. Restoration Bonds, also known as Reinstatement or Landfill Bonds, guarantee that land is returned to an agreed condition.

Other bonds include Retention Bonds, NHBC Bonds, Highway Act Bonds, Sewer Bonds, Pension Bonds and Environment Agency Bonds, amongst others. So as you can see, there is pretty much a bond for all needs.

Underwriting bonds

When a contractor approaches an insurer to act as surety for a bond, the underwriters will apply a set of criteria to determine acceptability. Firstly they will assess financial strength, net worth, liquidity and financial ratios. Secondly, they will evaluate the technical and commercial ability, previous experience and contractor’s existing workload. And lastly, they will consider the contractor’s systems and controls and managerial strength. Sometimes a face to face meeting will be required.

Other types of surety

Whilst performance bonds remain one of the most common forms of security, Parent Company Guarantees (PCGs) are also widely used.

PCGs are provided either by the contractor’s immediate parent company or another holding company. They serve as a guarantee to make sure a contract is properly carried out to completion. In the event of a breach of contract, the parent company is required to remedy the breach and will be obliged to meet all the contractor’s obligations and take the project to completion, matching the standards set down in the original contract.

Advice & guidance on bonds

It is advisable for contractors to take professional advice on the type of surety they opt for so that it suits their particular situation. And when tendering it is a good idea to look into which type of surety is preferred by the employer.

If you operate in the lift or construction industry and would like to find out more about the bonds available to you, please get in touch. You may also wish to look out for future posts covering indemnities and warranties.

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