Clifford Chance

The Clifford Chance Construction blog takes a look at potential solutions to the anticipated shortage of bank bonding facilities for construction and infrastructure projects.

A common feature of recessions is the drying up of bank bonding facilities and we cannot expect the current crisis to be any different given that, firstly, many companies have had to dig deep into and extend their current facilities during 2020 and, secondly, government loans support has not generally extended to 'frills' such as bonding facilities.

On-demand bonds (typically issued by banks) are habitually used in the industry to cover advance payments and retention. The logic is that the security needs to be liquid as it is replacing cash. There are more sector variances with true performance bonding where some prefer on-demand bonds (particularly those where project finance is utilised) whilst others (such as the UK development sector and the US domestic construction market) commonly use conditional surety instruments, or accept no bond security at all.

We can expect requests for more and larger advance payments with cashflow being so critical for contractors. Increasing offsite manufacture means this is the long term trend in any event. So where do parties go when the bank bonding facilities are not there?

• For advance payment and retention bonds, it is worth knowing that the leading sureties will provide vanilla on-demand bonding. Now, I know there are a few clients of ours who have had bad experiences calling on bonds from sureties in the past and may be concerned.  My recent experience with sureties on on-demand instruments is however positive, both in agreeing terms and claims. And even though they do not hold cash in the same way as a bank, they do not insist on massively extended payment periods
• For performance bonding, it is less common to see a surety issue a fully on-demand bond, but fast-track adjudication bond instruments (where payment is triggered on a decision by an adjudicator) are available which can mitigate cashflow risks, especially in insolvency situations.  The complexity of these instruments has reduced over time since we first started working on them in the late 1990s,  but they can still contain pitfalls for the unwary particularly in relation to the availability of an adjudication process during an insolvency situation.

Of course there has to be a fly in the ointment, and that is that sureties are typically restricted in the proportion of on-demand bonding they can issue. It will be interesting to see if Governments are prepared to step up in some capacity  (as co-surety, guarantor or re-insurer etc) – in particular in relation to the bonding of the increased advance payments for which the industry is calling. We have seen a few examples of this in specific infrastructure industries without it being part of a formalised programme as of yet.

Please let us know if you think this would be a useful initiative to help kickstart the industry.