Liga Asuransi – Dear reader, how are you? In this session, we are continuing discussions about risk management and insurance around construction projects.
Frankly, there are many aspects of risk that need to be known in detail in the construction sector. Both from financial risk and from a physical risk point of view.
As an illustration, the builder of a construction project starts from an idea or dream that wants to be realized. Then it was depicted visually by architects and engineers.
Then the drawing is tested and evaluated, after which a new method of workmanship is made, the materials needed, and the method of its work.
Well, here are the risks. First, there is a possibility of errors when architects and engineers create drawings. When it does not go as originally planned.
Secondly, when doing construction work there can be damages and losses due to natural disasters and other occupational risks.
A result of these risks causes financial losses, penalties, and loss of business opportunities.
Therefore, from the beginning, it is necessary to prioritize aspects of risk management and insurance so that losses that occur due to things that are beyond ability can be overcome.
As a senior insurance broker and consultant in Indonesia, this time we will focus on discussing the importance of performance bond guarantees for project owners.
If you are interested in this article, please share it with your colleagues so that they also know the same as you.
Why performance bond is important for project owners?
It is important for all parties involved in the construction industry to take affirmative actions to protect their investments in current and planned construction projects.
One of the ways owners and contractors can protect themselves is by ensuring that you understand how to enforce any performance bonds that you have required for your projects.
How Does a Performance Bond Work?
If a contractor (the principal) fails to meet the terms outlined in the contract, the project owner (obligee) can make a claim against the contractor’s bond seeking to recover financial damages. If a claim is valid, the surety will compensate the obligee on behalf of the principal up to the bond amount.
It’s important for contractors to know that performance bonds are fully indemnified, so in the event of a claim, the contractor is responsible for repaying the surety the amount of the claim plus expenses. In some instances, a surety may work with a project owner following a claim to hire a new contractor in lieu of providing a cash settlement to the project owner.
What Are the Benefits of Performance Bonds?
It’s easier to win bids. Non-bonded contractors are typically excluded from bidding on bonded projects by obligee’s.
The surety will pay for losses in the event you don’t fulfill the contract because of bidding errors or in the event you go bankrupt (though you do have to reimburse these funds later).
Performance bonds ensure only qualified contractors are bidding on projects of the appropriate size and technical requirements they are qualified for, which ensures projects that are started have a much higher likelihood of being seen through completion, free of defect. This makes the whole process smoother for everyone.
The Importance of Reviewing and Complying with Performance Bonds
Generally, it is the owner of the construction project who requires its general contractor to acquire a performance bond as assurance and protection against default by the general contractor under the prime contract. It is also possible, and common on large projects, for a general contractor to require its subcontractors to obtain performance bonds.
Additionally, they are sometimes required by the owners of private commercial construction projects. In fact, due to the negative economic impact of the current coronavirus pandemic, we can expect the frequency with which performance bonds will be required on commercial construction projects to increase.
Performance bonds are paired with payment bonds on government projects and are almost always paired with payment bonds on private projects. When paired together, these bonds are commonly referred to as “P&P” bonds.
Payment bonds are distinguishable from performance bonds in that they are intended to protect lower-tier contractors from the threat of non-payment by the general contractor or the contractor above them in the construction chain.
While a performance bond is intended to guarantee contract performance in accordance with contract terms, it can be rendered void and useless if the obligee fails to comply with any requirements contained in the bond.
Thus, it is critical for construction project owners and general contractors to read your performance bonds carefully to ensure that you do not take actions (or fail to take actions), which might negate your rights and protections under your bonds.
Performance bonds are treated and interpreted as contracts and can be breached and enforced like contracts. If there is a contractor default, the terms of the bond will lay out any actions that are required of the obligee before the surety’s obligations to correct the contractor’s default arise.
Additionally, the terms of the bond set out the surety’s liability and provide the actions it may take in responding to contractor default.
Many performance bonds contain provisions that require the obligee to provide the surety with notice of the contractor’s default before the surety’s obligations to cure the contractor’s default
Where notice of default is not provided to the surety, it is deprived of its mitigation rights and suffers injury.
Thus, where the obligee takes action by hiring a replacement contractor or otherwise fixes the contractor’s default before notifying the surety of the default and fails to provide the surety an opportunity to mitigate the damage from the contractor’s default itself, courts from other jurisdictions have concluded that the obligee has materially breached the performance bond and that the surety is excused from performing under the bond. It appears likely that North Carolina courts will adopt this reasoning if the issue arises.
Therefore, if you fail to provide proper notice of default under your performance bond, you could lose the right to enforce the bond and the valuable protection that it provides.
Performance bonds are very different from payment bonds. The surety is not guaranteeing that it will cover the costs of contractor default but is instead only guaranteeing to perform its obligations in accordance with the terms of the bond.
The very nature of a performance bond is that the surety does nothing on most projects.
When the surety does have to act, it is entitled to protect itself by receiving prompt notice and an opportunity to cure the default if the bond so requires.
If the bond provides multiple options for how the surety can correct the contractor default, the surety is entitled to exercise its right to select the option which is most advantageous to it. The obligee should be aware of the surety’s rights and should avoid interfering or injuring the surety’s rights under the bond.
The performance bond may require the owner to provide pre-default notice to the contractor and the surety or may require prompt notice of default and of the owner’s decision to terminate the contractor.
If the performance bond requires that the surety be provided notice before its duties to correct the contractor’s default arise, then it is in the owner’s best interest to provide the surety with such notice and to ensure the surety has the opportunity to be involved in the decision-making process on how to fix the contractor’s default.
Critically, even if the owner’s contract with the contractor gives it the right to terminate the contractor and to take steps to correct the contractor’s default, taking such actions without first reading the performance bond could result in a material breach of the performance bond. Thus, it is imperative that you review your performance bond before taking curative actions.
What is a contra bank guarantee?
In general, in Indonesia, performance bond guarantees are required using banks. Well, if the financial condition of the contractor (principal) is good and able to provide funds as much as required by the project owner, it may not matter.
But there is another alternative that is much more interesting, namely Contra Bank Guarantee or often also called Counter Bank Guarantee.
A Contra bank guarantee is a cooperation between an insurance company and a bank. If you take care of issuing Performance Bonds directly to the bank, you are usually asked to provide funds in the bank amounting to the guaranteed value. Your funds will be withheld during the life of the project.
If you use a contra bank guarantee, then the funds held are not your funds, but funds from the insurance company or guarantees provided by the insurance company to the bank. So, your funds are safe and can be used for other activities. Thus, the counter bank guarantee will be very helpful in terms of cash flow.
Now, most of the project owners prefer to have a contra bank guarantee.
How to arrange a Performance Bond?
Arranging the performance bond is like processing a loan to the bank. It’s not easy. Any information, documents, and supporting data, the underlying must be provided.
Banks and insurers need time to review all these documents. If there is incomplete information or it is not in accordance with the requirements or additional information is needed.
If you take care of it yourself, you must be overwhelmed. Especially if you want to get a contra bank guarantee.
Therefore, you need the help of an insurance brokerage company that simultaneously acts as your consultant.
An insurance broker is an insurance expert who is on your side, much different from the insurance agent because the agent is on the side of the insurance company he is in charge of.
An insurance broker will help you to contact an insurance company that can provide performance bond guarantees that you need. In addition, the insurance broker will also take care of the issuing bank in accordance with the terms of the contract.
With the help of an insurance broker, the issuance process becomes faster and meets the requirements of the contract.
One of the widely experienced Indonesian insurance broker companies that has successfully issued thousands of guarantees and bank guarantees is L&G Insurance Broker.
For all your project insurance needs, contact L&G right now!
Sources:
- https://www.natlawreview.com/article/importance-reviewing-and-complying-performance-bonds
- https://www.californiacontractorbonds.com/contract-bonds/performance-bond/
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