Explainer: Guarantees in the Construction Industry

Guarantees in the construction industry, as in most other sectors, are contracts that provide security for the payment of compensation in the event of default by the contractor.

The ultimate purpose of a construction guarantee is to protect the client from increased building costs due to the contractor’s failure to do his duties according to the terms of the construction contract.

Construction contracts guarantees

From performance guarantees to retention guarantees and advance payment bonds, here is a list of the various types of construction guarantees and what they protect:

1. Performance guarantee

Of all the different types of guarantees in construction contracts, a performance guarantee is easily the most common form of surety. It protects the project owner against the risk of the contractor failing to complete the project on time and within budget.

The main purpose of this guarantee is to shield the owner from cost escalation resulting from the non-performance of the contractor.

The guarantee amount is usually 10% of the contract amount, and it is meant to help the client meet the costs associated with finding a new contractor to complete the project.

EXPLAINER: Submittals in Construction

2. Retention guarantee

This guarantee replaces the retention fund (held by the client), which is used to fix defects observed at the end of the contract.

Ordinarily, most contracts allow the client to keep a percentage (often 5%) of the amount due to the contractor as a form of security against defective work.

However, the two parties can sign a retention guarantee where the client agrees to release all the funds due to the contractor who then provides a bond to secure the amount that would have been retained. 

A retention guarantee allows the contractor to free up retention funds, to boost working capital while giving the client security to pay for the defects in case the contractor fails to complete the project well.

3. Advance payment guarantee

In some instances, a client is required to make payments to the contractor before construction begins. This happens in situations where a contractor incurs major costs before the commencement of the contract.

The client secures this payment by asking for an advance payment guarantee in return.

The guarantee also shields subcontractors from struggling contractors who dedicate all the monies to honouring their building agreements while failing to pay their suppliers and subcontractors.

4. Bid guarantee

Bid bonds are usually required in big dollar tenders. They are submitted with a tender to compensate the client if the contractor does not or cannot begin the project.

The bond is fully or partly forfeited if the winning contractor fails to execute the contract for any reason or is unable to meet other specified terms.

Bid guarantees create incentives for serious tendering and contribute to eradicating oddly low bids. However, these bids are open to misuse by the client and may discourage small firms from tendering.

5. Off-site materials guarantee

In some cases, the client can be required to pay for items that are yet to be delivered on-site. For example, the client can release a large sum of money to the contractor for payment of equipment or materials that are still at the manufacturer’s premises. 

Under these circumstances, the client will require an off-site materials bond to secure the payment against default by the contractor. The bond is often up to the value of the off-site items and it keeps reducing as deliveries to the site are made.

6. Adjudication bond

These are conditional bonds payable on an adjudicator’s judgment. The bonds are provided by a third-party adjudicator chosen by both the client and the contractor and are used for swift dispute resolution.

Adjudication bonds are most appropriate when the adjudicator’s verdict is final and binding.

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