In the second in our series of practical tips for taking control of your legal affairs, Geraldine Laing explains how and when to call on a performance bond

What is a performance bond and do I need one?

Performance bonds have become increasingly important in the current climate, as they may provide a way of recovering some of your costs if a contractor or subcontractor becomes insolvent.

These bonds are issued by banks or insurance companies, and the cost of obtaining one is normally included within the contract sum. They provide a pot of money that can be used to cover the additional costs of getting someone to finish the job. The amount that can be claimed is generally capped at a fixed amount (normally 10% of the contract sum) and the bond will have an expiry date – usually 12 months after the date of practical completion.

The most common form in the UK is the Association of British Insurers Model Form of Guarantee Bond.

When can I call on my bond?

Performance bonds can only be called when the contractor has “breached” the building contract, as opposed to “on demand” bonds which can be called at any time, regardless of fault.

What amounts to breach depends on the terms of the underlying building contract, but can include insolvency, failing to proceed with the works or failing to comply with the employer’s instructions.

In some contracts, insolvency leads to automatic termination, and does not constitute a breach of contract unless the contract provides otherwise. In these circumstances, the bond cannot be called unless it expressly states that it can.

When it is inappropriate to call on one?

Do not call on a performance bond unless you can show that the contractor has committed a breach of contract, which has or will cause the employer to incur damages or costs, and the contractor is unwilling or unable to pay.

You should not call on a bond if the claim is disputed, if the contractor has a valid counterclaim against you, or the matter is still the subject of adjudication or litigation. The liability of the guarantor is the same as the contractor’s under the building contract, and the performance bond is not intended to provide immediate payment where there isn’t such a right under the building contract.

Calling on a bond should not be done lightly – it can cause serious damage to the reputation of a contractor, and will result in it having to reimburse the guarantor for sums paid out. It may also affect their ability to obtain bonds in the future, and their ability to obtain further work.

My contractor is insolvent. How soon can I get my money?

A guarantor will not pay out until the amount owed has been properly calculated under the terms of the building contract. For example, if the contractor is insolvent, the increased cost of completing the works can only be calculated after practical completion. In this case you must submit the claim, but will not be paid until after the works are completed. This is particularly important if you are coming close to the bond expiry date. As long as details of the basis of your claim are submitted before the bond expires, the remedies under the bond are preserved.

So what do I do next?

Write a letter to the guarantor setting out the grounds for the claim and demanding payment of the amount owed. This must be done before the expiry date, otherwise the entitlement will lapse.

Make it clear which performance bond you are referring to by attaching a copy or giving the reference number, names of parties and date of the bond. Some bonds include provisions specifying how and when notice should be given, and if so these should be complied with – for example, by fax or by post.

I have written to the guarantor and received a response stating that it will not pay out. What is the next step?

It depends on its reason for non-payment. If the guarantor is refusing to pay because the amount claimed is not yet due (as mentioned above), then you will have to wait until you can work out the amount owed using the appropriate provisions of the building contract. The guarantor must pay out once an amount has been ascertained as due under the building contract.

If the guarantor refuses to pay because it disputes the actual amount, it will be liable for interest and costs as a result of its delay. In the worst case scenario, you may find yourself in litigation, although most claims are resolved before this stage – the courts are not sympathetic to a guarantor that tries to avoid payments under a bond when there are no valid grounds to do so.

Finally, it is worth noting that a guarantor may be justified in refusing to pay as a result of a failure to comply with the correct notification provisions in the bond, or a notifications made after the expiry date, so it is important that you check and comply fully with any such provisions.