A contract bond secures a supply or service obligation outside construction.

Where a non-construction contract bond is required

The requirement usually originates with the customer rather than with the supplier. A buyer committing to a significant order, a public body awarding a multi-year service contract, or a landlord granting a concession will often make security a condition of the award.

The settings below are the ones most commonly encountered outside the building industry.

Common non-construction bond settings

• Supply of goods agreements, where the buyer needs protection against non-delivery or defective delivery of a substantial order
• Outsourced service contracts, including facilities management, cleaning, security services, catering and fleet services
• Maintenance and support agreements running over a defined term
• Public-sector tenders, where security is a condition of award under the tender documents
• Concession and operating agreements, where a party is granted the right to operate a facility subject to obligations
• Manufacturing and equipment supply, including the commissioning obligations that follow delivery
• Distribution and agency arrangements where a principal requires security for stock or collections

Supply of goods bonds

A supply of goods bond secures the supplier's obligation to deliver goods conforming to the contract, within the agreed period and at the agreed price. The buyer's exposure is the cost and disruption of sourcing elsewhere if the supplier does not deliver, which on a large or specialised order can substantially exceed the value of the goods themselves.

The underwriting focus follows that exposure. A guarantor will want to understand where the goods come from, whether the supplier manufactures or imports them, what the lead times are, and how exposed the arrangement is to currency movement, import delay or a single upstream supplier. A trading business reselling imported goods presents a different risk from a manufacturer producing them.

Where goods are imported, the supplier's own customs and clearance arrangements become part of the picture, because a delay at the border is a delivery failure as far as the buyer is concerned.

Read the customs bonds guide →

Service contract bonds

Where the obligation is to render a service over a period, the security supports continuity rather than a single delivery. A facilities management contract, a security services contract or a maintenance agreement creates an ongoing obligation, and the customer's exposure is the cost of replacing the provider at short notice.

That changes what matters. Staffing levels, the ability to retain skilled people, subcontracting arrangements, the service level regime and the consequences built into the contract for failing to meet it are all relevant. A provider that has run comparable contracts to term is a materially different proposition from one that has not.

Public-sector service contracts add a further layer, because the tender documents frequently prescribe both the amount of the security and the wording, leaving little room to negotiate the instrument itself.

Demand bonds and accessory obligations

The same distinction that governs construction security applies here. A demand bond creates an obligation independent of the underlying contract, so the guarantor pays on a compliant demand and cannot resist payment because the supplier disputes whether it was in breach. An accessory suretyship is tied to the underlying contract and allows that dispute to be raised.

The Supreme Court of Appeal has confirmed that a properly drawn demand instrument is wholly independent of the underlying contract, comparable to an irrevocable letter of credit, and that the guarantor's only escape is proof of fraud by the beneficiary, an exception within a narrow compass.

The court has also made clear that the description on the document does not settle its character. What is referred to as a guarantee may constitute no more than an accessory obligation, and it is the terms of the instrument itself that determine its nature. For a supplier signing a bond prescribed by a customer, that is the clause worth reading first.

Source: Lombard Insurance Co Ltd v Landmark Holdings (Pty) Ltd 2010 (2) SA 86 (SCA); Compass Insurance Co Ltd v Hospitality Hotel Developments (Pty) Ltd 2012 (2) SA 537 (SCA) at paragraph 15.

How a contract bond is underwritten

A guarantor is being asked to stand behind the supplier's ability to perform, so the review is a credit and capability assessment. Financial standing establishes whether the business can absorb the cost of performing, and operational history establishes whether it can actually do the work.

As with construction security, capacity is assessed across the whole book. Bonds already in issue on other contracts consume the same facility, so a supplier bidding for several secured contracts at once needs to plan for that rather than treat each in isolation.

Information usually requested

• Annual financial statements and recent management accounts
• The contract or tender document creating the obligation, and the bond wording required
• Contract value, term, delivery or service schedule and payment terms
• Details of upstream suppliers, subcontractors and any single points of dependency
• A record of comparable contracts completed to term, with references where available
• Management experience in the specific sector and contract type
• Bonds already in issue and remaining facility capacity
• The counter-indemnity, and any suretyships from directors or a holding company

The counter-indemnity is the real exposure

If the guarantor pays the customer, it will normally recover that payment from the supplier under the counter-indemnity. The bond therefore does not transfer the obligation. It converts a demand for cash security into a credit facility, and leaves responsibility for performance exactly where it was.

Where the counter-indemnity is supported by suretyships from directors, the exposure extends beyond the company. That is a decision to take deliberately, with an understanding of the value of the bond and the circumstances in which a call can be made, rather than as an administrative step at the end of a tender process.

Release, expiry and capacity

A bond that has served its purpose but has not been released continues to occupy facility capacity. Final delivery, the end of a service term, the expiry of a warranty period and the acceptance of the last milestone are all points at which security should be returned or reduced.

Keeping a register of bonds in issue, the event that ends each one and whether it has actually been released is a simple control with a direct effect on the ability to bid for further work.

Where the contract is a building contract

Where the obligation involves building or engineering works, the standard form contracts prescribe both the instruments and, in the case of the JBCC agreement, the amounts. That is a distinct analysis and is dealt with separately.

Read the construction guarantees guide →

Bonds sit alongside the insurance programme

A contract bond protects the customer against the supplier's failure to perform. It does nothing for the supplier's own exposures. Damage to stock and premises, liability to third parties, interruption of the supplier's own operations and the risks that attach to running the business remain the subject of conventional insurance.

A supplier whose ability to perform depends on a single facility should give particular attention to how an interruption at that facility would be funded, because the bond will not answer it.

Read the business interruption insurance guide →