A lot of people think of performance security under a construction contract to be bank guarantees, collateral, and other cash retentions. Then again, they are not the only options present because construction claims experts have decided to explain to us the different kinds of security which are present in a construction contract.
What are cash retentions?
Cash retentions are the most common kind of security, especially for smaller contracts as they often involve retaining cash. It involves withholding a small amount of money from the claim of the contractor (usually around 10 percent of the claim). This is done unless and until a certain value of the security has been accumulated which is usually almost 5 percent of the contract sum.
One of the main benefits of such an arrangement is due to its simplicity. But it can backfire and can affect the contractor’s cash flow adversely. Head contractors need to understand that such an agreement may not be effective in cases where the obligation to release security depends on operations of another similar contract.
Using Insurance bonds
They are also known as surety bonds. Insurance bonds resemble bank guarantees in the way they are issued by a third-party financial institution. This usually acts as an intermediary between an insurance company, a bank, a contractor, and the construction company. They are payable on demand to the beneficiary.
The difference between a bank guarantee and an insurance bond is that issuers of the latter usually don’t need the bond to be secured by a cash deposit. The result? The insurance bonds are often better for the contractor’s cash flow.
However, the flip side is that the upfront costs associated with an insurance bond are usually higher than those of a bank guarantee.
Can a separate bank account work?
This serves as an alternative to cash retention where at times the security amount will be paid into a separate bank account. This account will be controlled by the parties involved, or can work as a trust account of a solicitor.
The purpose of this arrangement is giving the contractor more comfort over collateral and construction security. Eventually they will receive the security amount once the obligations have been fulfilled. It has a disadvantage like the previous one and here, the adverse impact of this arrangement on the contractor’s cash flow.
A lot of states in the United States and Australia have begun mandating project bank accounts as part of the security of payment legislation. This is especially true for Governmental projects or projects which are of a large scale.
Understanding Bank guarantees and what they do?
This basically is an undertaking a bank gives to construction companies and contractors. It helps the involved parties in taking security from contractors (usually in the form of cash) so as to make sure they are protected in case the bank guarantee is needed.
Many contractors prefer bank guarantees to cash security. The main reason for this is to avoid the negative impact on cash flow associated with cash retention.
What is a letter of comfort?
A letter of comfort is a sort of an assurance given by a third party. It could be a bank, an accountant or a relevant corporate body. This is about the financial standing and situation of any entity in a construction project. However, it cannot b retreated as security as it is regarded as an inferior kind of security.
The value of a letter of comfort depends on what is said in it. Suppose the letter is not properly representing the contractor’s financial position; in any way, if it makes representations about future matters without any proper reasoning then the contractor could find themselves liable for a breach of conduct provisions present in various laws in various states and countries.
Is a mortgage over land a better kind of security?
Though unusual in nature, A Dubai based quantum expert working at a well known firm of construction claims explains that the practice of mortgage over land is used as a security in an already working construction contract. In such a context, mortgages are rare due to the following factors:
The parties will normally be able to agree on a different regime without the need fr opting for a mortgage.
Contractors are usually not inclined to provide this kind of security.