The instruments used on a South African construction project
Most construction security falls into a small number of recognised forms. They are often issued by the same guarantor under one facility, but they are separate undertakings with separate wordings.
The list below sets out the instruments most commonly encountered. Which of them an employer requires is a matter for the contract, and not every project uses all of them.
Construction guarantees commonly required
- Bid or tender guarantee, supporting the tenderer's undertaking to enter into the contract and provide the required performance security if the tender is accepted
- Performance or construction guarantee, supporting the contractor's obligation to carry out and complete the works
- Advance payment guarantee, securing repayment of money paid to the contractor before the corresponding work has been performed
- Retention guarantee, released to the contractor in place of retention money the employer would otherwise hold back from payments
- Materials off-site guarantee, supporting payment for materials that have been paid for but are not yet delivered to the site
- Supplier or subcontractor surety, securing the obligations of a supplier or subcontractor to the main contractor
What the standard form contracts require
The amount of the performance security is set by the contract rather than by the guarantor. Under the JBCC Principal Building Agreement the employer may require either a fixed construction guarantee of 5% of the contract sum, or a variable construction guarantee with an initial value of 10% of the contract sum which reduces automatically as contract milestones are met.
The two options behave differently for the contractor. A fixed guarantee stays at its face value for the duration, while a variable guarantee starts higher but steps down as the project progresses, releasing capacity along the way. Which is preferable depends on the contract period, the payment profile and how much guarantee capacity the contractor has available across its other projects.
The FIDIC forms take a different approach and do not fix a percentage. The amount of the performance security is stated in the contract particulars, which makes it project-specific and negotiable. A contractor pricing a FIDIC project should therefore read the particulars rather than assume a market-standard figure.
Source: JBCC Principal Building Agreement, construction guarantee options; FIDIC conditions of contract, performance security stated in the Contract Data. Contractors should confirm the requirement in the actual contract documents for the project concerned.
Demand guarantees are independent of the building contract
The most consequential feature of a construction guarantee is that it is usually drawn as a demand guarantee. That means the guarantor's obligation is independent of the building contract, and a dispute about workmanship, delay, variations or payment does not entitle the guarantor to withhold payment.
The Supreme Court of Appeal has compared such guarantees to irrevocable letters of credit used in international trade. The obligation to pay arises on a compliant demand, the guarantor has no obligation to investigate the propriety of the claim, and the only basis on which it can escape liability is proof of fraud by the beneficiary, an exception falling within a narrow compass.
That position was confirmed firmly in a 2013 appeal, where the court held that liability under a construction guarantee was absolute and unconditional, that disputes in relation to the construction agreement were precluded, and that an earlier majority decision suggesting otherwise was clearly wrong. A contractor should therefore not assume that an arbitration or adjudication about the underlying contract will stop a call on the guarantee.
Source: Lombard Insurance Co Ltd v Landmark Holdings (Pty) Ltd 2010 (2) SA 86 (SCA); Coface South Africa Insurance Co Ltd v East London Own Haven t/a Own Haven Housing Association 2014 (2) SA 382 (SCA).
Not every document called a guarantee is a demand guarantee
The heading on the instrument does not decide its character. The court has observed that what is referred to as a guarantee may constitute no more than an accessory obligation, and that it is the terms of the guarantee itself that will determine its nature. An accessory suretyship is tied to the underlying contract, which changes the position of both parties substantially.
The practical consequence is that a contractor and an employer can each be wrong about the same document. An employer relying on what it believes is on-demand security may find the instrument is accessory and the underlying dispute can be raised. A contractor assuming it can resist a call by pointing to a dispute may find the instrument is autonomous and payment follows the demand.
Source: Compass Insurance Co Ltd v Hospitality Hotel Developments (Pty) Ltd 2012 (2) SA 537 (SCA) at paragraph 15.
The demand itself has to comply
Where a guarantee sets out what a demand must contain, that requirement has to be met. In one matter a construction guarantee required a court order placing the contractor in liquidation to be attached to the demand. No order was attached, the demand was non-compliant and the guarantor was not liable to pay.
The court expressly declined to decide whether strict compliance is required for performance guarantees, because the requirements in that document were absolutely clear and had simply not been complied with at all. The useful rule for both parties is the narrower one: read the demand mechanics in the instrument, because that is what determines whether the security can actually be used.
Source: Compass Insurance Co Ltd v Hospitality Hotel Developments (Pty) Ltd 2012 (2) SA 537 (SCA) at paragraphs 13 and 14.
How a construction guarantee is underwritten
A guarantor is being asked to stand behind the contractor's ability to complete the works, so the assessment looks like a credit and capability review rather than an insurance quotation. Financial standing, the current order book, the contract itself and the contractor's history of comparable projects carry the most weight.
Capacity is assessed across the contractor's whole book, not project by project. A contractor running several guaranteed contracts at once is consuming a single facility, which is why the release of completed guarantees matters as much as the issue of new ones.
What a guarantor typically examines
- Annual financial statements and recent management accounts, with particular attention to working capital
- The contract documents, including the guarantee wording the employer requires
- Contract value, programme, payment terms and the retention and advance payment arrangements
- Completed projects of comparable size, complexity and sector
- The experience of the site and contracts management team
- Existing guarantees in issue and the capacity remaining under the facility
- The counter-indemnity, and any suretyships from directors or a holding company
Release matters as much as issue
A guarantee that has served its purpose but has never been formally released continues to occupy capacity that the contractor could otherwise use to tender for new work. Practical completion, the expiry of the defects liability period and the conversion of retention are all points at which security should be returned or reduced.
Variable guarantees that reduce automatically on defined milestones help with this, but they still depend on the milestone being recognised. Keeping a register of guarantees in issue, their expiry events and their release status is a straightforward control that directly affects tendering capacity.
The guarantee does not replace the insurance programme
A construction guarantee protects the employer against the contractor's failure to perform. It does nothing for the contractor's own exposures. Injury to third parties, damage to the works, plant, materials, liability arising from site operations and the contractor's own business risks are dealt with by conventional insurance and remain necessary alongside the guarantee.
Public liability exposure on a construction site is particularly worth reviewing separately, because site operations frequently affect neighbouring property and members of the public who have no contractual relationship with anyone on the project.
Read the public liability insurance guide →
Where a contract is not a construction contract
Supply agreements, service contracts and concession arrangements can require security using very similar mechanics without involving any building work. Those instruments are dealt with separately, because what the underwriter examines changes when there is no site, no programme and no practical completion.
Read the contract bonds guide →
COMMON QUESTIONS
Construction guarantee questions, answered clearly.
What is a construction guarantee?
It is security provided by a contractor, usually through a licensed insurer or a bank, under which the guarantor undertakes to pay the employer if the contractor fails to perform its obligations under the building contract. It protects the employer, not the contractor.
How much is a construction guarantee in South Africa?
The contract sets the amount. Under the JBCC Principal Building Agreement the employer may require either a fixed construction guarantee of 5% of the contract sum, or a variable construction guarantee with an initial value of 10% of the contract sum which reduces automatically as contract milestones are met. The FIDIC forms do not fix a percentage; the amount is stated in the contract particulars.
What is the difference between a fixed and a variable construction guarantee?
A fixed guarantee remains at its face value for the duration of the contract. A variable guarantee begins at a higher initial value and reduces automatically as defined contract milestones are met, which releases guarantee capacity as the project progresses.
Can an employer call on the guarantee while the contract is in dispute?
Where the instrument is a properly drawn demand guarantee, the Supreme Court of Appeal has held that liability is absolute and unconditional and that disputes under the construction agreement are precluded. The narrow exception is proof of fraud by the beneficiary. Where the instrument is in truth an accessory obligation the position differs, and the wording governs.
Does the guarantor investigate the claim before paying?
Under a demand guarantee the courts have held there is no obligation on the guarantor to investigate the propriety of the claim. Its concern is whether the demand complies with the terms of the guarantee.
What is a bid or tender guarantee?
It supports the tenderer's undertaking that, if its tender is accepted, it will enter into the contract and provide the performance security required. It addresses the employer's cost and delay if a successful tenderer withdraws.
What is a retention guarantee?
It is provided to the employer in place of retention money that would otherwise be held back from payments due to the contractor. The contractor receives the cash and the employer holds security instead, which improves contractor cash flow without removing the employer's protection.
What is an advance payment guarantee?
It secures repayment of money advanced to the contractor before the corresponding work has been performed, so that the employer can recover the advance if the work is not carried out.
Does a construction guarantee replace contract works or liability insurance?
No. The guarantee protects the employer against the contractor's non-performance. Damage to the works, plant and materials, injury to third parties and the contractor's own liability exposures are dealt with by conventional insurance and remain necessary.
What happens if the guarantor pays out?
The guarantor will normally seek to recover the payment from the contractor under the counter-indemnity, which is frequently supported by suretyships from directors or a holding company. A guarantee provides liquidity and access to work; it does not remove responsibility for the obligation.
