It covers the risk of contractors non-performance. The guarantor (Insurer) will pay out to the agreed amount if the contractor fails to complete (or defaults on) the project as stated in the contract.

It provides a safety net for the employer to cover costs of delay, reworks or hiring a replacement contractor.

The bond is usually a fixed percentage of the contract value (Usually 10% of the contract’s total sum).

Performance guarantees are issued upon being awarded a contract and remain in force for the duration of the project. Most standard contracts require contractors to submit a performance guarantee within a certain amount of days after being awarded the contract.

In South Africa JBCC’s Standard contract, the guarantee can be structured in two ways: Either a fixed 5% of contract sum until completion or a 10% that gradually reduces at building milestones. In either case the bond provides continous security to the employer during the contract duration.

The employer is the direct beneficiary. They receive financial cover is a contractor defaults, ensuring funds are available to complete the project.

This greatly reduces risk for the employer. Contractors do not directly benefit from this bond, however it does benefit the contractor’s cash flow. Unlike a bank guarantee, an insurer-backed bond doesn’t tie up 100% collateral, allowing contractors to preserve credit for the project’s execution. It also gives the employer a higher confidence in hiring the contractor if they have taken out this cover.

Yes, in theory. Often guarantees carry clauses making them “on-demand”, meaning the employer can call for payment simply by stating you are in breach, without proving it first. However, insurers investigate calls and may resist unfair demands, unlike banks which usually pay immediately.

If the Contractor defaults, or fails to honour their obligations, the Owner/Employer may call on the Performance Guarantee in order to complete the Contract. The Insurer then pays the Employer the agreed-upon guarantee amount so they can find a new Contractor to complete the project. In most cases, the Insurer will hold the Contractor liable and will expect reimbursement of the amount paid.

If valid, the insurer pays the employer the guaranteed amount (up to the stated limit). The insurer then has a right of recovery against you, meaning you must repay the insurer for the amount paid out.

Yes, in many contracts. Instead of the employer holding back cash retention from your progress payments, they accept a guarantee of equal value. This helps improve your cash flow.

• Company profile (including an organogram and copies of the current and previous contracts)
• Two years’ financial statements and three months’ bank statements
• Letter of appointment
• Contract information
• Guarantee wording requirements
• Company registration documentation
• Copies of all members’ identity documents and income tax numbers
• Copy of letterhead
• Tax clearance certificates
• CIDB certificate

All applications are subject to a thorough analysis to establish the Contractor’s risk profile. This will include an assessment of the Contractors’ financial standing and their resource capabilities to fulfill the Contract obligations.

For Corporate Clients, emphasis is placed on:

• • the financial standing of the Contractor
  • the company structure and shareholding
  • the Contract information
  • the Guarantee wording requirements
  • the securities available

Liquidation of the contractor’s business is one of the most common reasons for a guarantee to be called up. Liquidation automatically places the contractor in default of the contract and will thus trigger a claim for the performance guarantee.

The employer needs the project to be completed and will have to arrange for a replacement contractor. This causes delays and an inevitable increase in costs.

The Contractor expressly refusing to perform its obligations and perform under the contract gives the Employer the right to terminate immediately and call up on the performance guarantee.

Example:

Eskom Holdings Soc Ltd v Hitachi Power Africa (Pty) Ltd and Another (139/2013) [2013] ZASCA 101 (12 September 2013)

Eskom presented three performance guarantees for payment – a number of disputes had arisen between the parties concerning the performance by Hitachi of its obligations under the construction contract. Eskom alleged that Hitachi had been guilty of material and ongoing breaches of the construction contract. It complained that Hitachi had delayed the completion of the first operating unit at Medupi. It also claimed that in view of the said material breaches, it was entitled to demand payment under the guarantees.

• On-Demand vs Conditional Bonds:

  • An on-demand bond can be called by the employer simply by stating you are in breach—no need to prove it in court first. These are common in South Africa.

  • A conditional bond requires the employer to prove actual damages before the insurer pays.

• Employer’s Right vs Fairness: Even if you dispute the claim, most performance bonds are drafted in favour of the employer. Insurers sometimes resist unfair calls, but banks usually pay immediately on-demand.

• Right of Recovery: If the insurer pays out, they have the right to recover the amount from you. The guarantee is ultimately your liability.