ABI Model Form of Guarantee Bond: fit for purpose?

The model form of guarantee bond published by the Association of British Insurers (ABI) has, for some time, been seen as the "go-to" performance bond by many in the construction industry. It is typically the template of choice for sureties reluctant to use bespoke forms. The ABI considers the model form to be generally suitable for use without amendment but does it really provide clients with the recourse it should? The recent case of Ziggurat (Claremont Place) LLP v HCC International Insurance Co Plc [2017] has brought the issue back into the spotlight and raised the issue of whether clients take too much comfort from the mere existence of a bond without giving sufficient attention to the detail.

Why seek a bond?

Performance bonds are intended to provide clients with financial security from a third party in the event that the contractor fails to fulfil its obligations under the building contract. Having a bond in place is also often a prerequisite to funding.

In the UK development market a typical bond allows the client (the beneficiary) to recover a maximum sum of 10% of the value of the building contract - but sometimes more - from the surety following a contractor breach. A contractor insolvency will typically lead to a breach and may therefore lead to a pay-out under the ABI model form.

For cash-flow dependent clients, prompt payment from the surety could be a decisive factor in project outcome.

ABI model form of guarantee bond

Under the ABI model form the surety's obligation is to:

"satisfy and discharge the damages sustained by the Employer as established and ascertained pursuant to and in accordance with the provisions of or by reference to the Contract and taking into account all sums due or to become due to the Contractor." (emphasis added)

The explanatory guide that accompanies the ABI model form confirms that it provides the client with an entitlement to damages immediately once the contractor becomes liable under the building contract. This all sounds straightforward but it is important to remember that conditional bonds such as the ABI model form are secondary obligations – the surety will only pay once the valuation mechanism under the building contract is exhausted.

"Established and ascertained" under standard form building contracts

Under the JCT Design and Build Contract 2016, to "establish and ascertain" the client's loss following a material breach by the contractor could involve an adjudicator's decision followed by lengthy court or arbitral proceedings. This could take months or years. In the case of a contractor insolvency, the client's losses will not be certain until a future date which will be determined by whether the client decides not to continue with the works or appoints another contractor to complete them. Again, the accounting exercise following contractor insolvency may not occur for months or even years, and even then it could be challenged.

In the event of the contractor's insolvency, should the client choose to continue with the project, its cash flow will be impacted by the unexpected costs of engaging and mobilising a new contractor and yet it may not be able to seek recourse from the surety until the final accounting process under the new contractor's building contract has taken place. 

The position is better for clients under the NEC4 contracts, where the final assessment is made no later than four weeks after the Defects Certificate is issued or thirteen weeks after a termination certificate. The client's cash reserves may nevertheless be tested whilst the final assessment is awaited.

Amendments to ABI

In order to allow for quicker recovery under the model form, bespoke amendments are needed. Most preferably for clients this can be achieved by requiring the surety to pay out the losses notified to it by the client. While this mechanism resembles that found in an on-demand bond, it is dependent on a contractor breach and therefore making a claim remains conditional on contractor default, i.e., it is still an on-default bond.

Where a surety will not accept this, a compromise might be to include an acknowledgment that the surety will satisfy an adjudicator's decision in respect of the client's losses. This could go some way towards solving the delayed payment issue mentioned above. For example, although each party would typically need to bear its own costs of an adjudication, there would be an enforceable decision within 28 days of referral to the adjudicator which the surety would have to comply with. The client would receive payment subject to its return to the surety should the decision later be overturned. This compromise could impact the bond premium, but for some clients it might be more valuable than a bond which does not pay out timeously.

Bond mitigation

Aside from bonds, what other performance security might a client seek? A parent company guarantee (PCG) is particularly useful where the contractor entity is one branch of a wider group of companies. There should be no additional cost for the client and a well-drafted PCG will cover all the contractor's obligations and liability for defects for 12 years from practical completion. However, a PCG operates differently to a bond: it provides the client with a performance remedy that focuses on the completion of the works, whereas a pay-out under a bond is a compensation remedy for the loss suffered.

Project bank accounts (PBAs) are designed to eliminate cash-flow problems which so often plague the industry. The ability to achieve security and speed of payment to sub-contractors in particular will provide the client with greater certainty that a project can continue in spite of the main contractor's breach. Recently, both the Scottish and Welsh governments have mandated that project bank accounts are used on public sector building projects above a threshold (£4m in Scotland, and £2m in Wales). Set-up costs are often the prohibitive factor on smaller projects but, as the use of PBAs becomes more widespread, prices may become more competitive.

Final thoughts

The mere presence of a bond should not provide automatic comfort to clients and their funders hoping to receive a timely pay-out when the contractor is in breach of contract. The terms of the bond should be scrutinised with the same depth as the building contract to understand when the surety has to dig into its pockets. Ultimately, it will be a commercial decision for the client as to whether it thinks the recourse obtainable under the bond justifies the cost. Other, cheaper alternatives may offer better protection.