On-demand bonds require winning bidders to place a sum of money with their bank that can be collected by the client at its discretion, without having to prove through legal action that the specialist contractor had defaulted on its contract. Professor Rudi Klein, barrister and chief executive at SEC Group, highlights what contractors should look out for.
Customers or clients often require on-demand bonds as security for performance of your contractual obligations. Firms should resist such bonds. After all the client already has extracted sufficient protection: rights of set-off; retention; parent company guarantees; liability insurance policies; third party warranties; as well as damages for delay and other breaches of contract.
On-demand bonds are exactly as described. The client can demand that the issuer of the bond (or bondsman, usually a bank) pays him the bonded amount, generally 10 per cent of the contract value, without having to prove any fault on the part of the specialist contractor. The bank then takes the bonded amount plus its fee from the specialist contractor’s account. In other words they are as good as cash!
The amount may be ring-fenced in the account thus reducing any overdraft facilities for the term of the bond. Typically, a bank charges £200 per £100,000 contract value as a set up cost but this may vary from job to job. An annual fee may also be charged for keeping the bond open.
In the absence of fraud on the part of the clients it’s very difficult to challenge a call on the bond. If there are any procedural requirements for making a call the customer must follow the requirements to the letter. This was one of the issues that arose in a recent legal case.
In this case the terms of the on-demand bond required the customer – when making a call – to accompany it with a written claim. The contract between the parties further required that the claim be supported by a written statement setting out the ground(s) of the claim and a summary of the supporting material facts. Since this was not done the court held that the call on the bond was invalid.
If you have to accept an on-demand bond you should:
- carefully check the customer’s financial standing; poorly resourced companies may be tempted to make a call on an on-demand bond;
- ensure that the bond has a fixed expiry date and, if possible, that it is linked to the anticipated date of handover;
- insist on a clause in the contract (or in the bond) that a call on the bond cannot be made until an adjudicator’s decision has been issued in respect of any disputed matter; or
- if the above is not achievable, insist on a fall-back clause that the bond cannot be called until you have had a period (say 28 days) in which to resolve any issue giving rise to a call on the bond;
- ensure that your bank notifies you immediately that a call has been made on the bond;
- record in your diary the dates of release of outstanding bonds and also names of the individuals within your customer’s organisations responsible for releasing the bonds (the bank is likely to have a pro forma for this purpose).