Customers often require on-demand bonds as security for performance of your contractual obligations. Firms should resist such bonds. After all, the clients have already 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. Clients can demand that the issuer of the bond (also known as a bondsman, usually a bank) pays them the bonded amount – generally 10% of the contract value – without having to prove any fault on your part. Your bank then takes the bonded amount plus its fee from your account. In other words, they are as good as cash.
The amount may be ring-fenced in your account, thus reducing your 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 between jobs. An annual fee may also be involved to keep the bond open.
In the absence of fraud on the part of the client it is very difficult to challenge a call on the bond. If there are any procedural requirements for making a call, the customer must follow these 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 these requirements were not followed, the court held that the call on the bond was invalid.
What you should do
If you have to accept an on-demand bond, you should take the following steps:
- 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, make sure this is linked to the anticipated date of handover.
- Insist on a clause in your 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.
- If the above is not achievable, insist on a fallback 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 your bank notifies you immediately when 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 customers’ organisations responsible for releasing the bonds – your bank is likely to have a pro forma for this purpose.
Professor Rudi Klein is chief executive of SEC Group