The purpose of Bonds and Guarantees is to provide the buyer with insurance of sorts should there be a failure by the seller to meet their contractual obligations. In the event there is a failure to deliver the services or goods to the Buyer, the bond can be ‘called’ and the Buyer can receive financial compensation from the bank.
A Bid Bond helps to provide security and trust that a contractor is financially in the position to take on a project, should it be awarded to them. These bonds are usually between 2% and 5% of the total contract value, and it serves as a deterrent to frivolous tender offers. If there is no bid bond in place, it is possible for a contractor to be awarded a project, but not actually start. This would leave the supplier of the tender without a contractor. If a bid or tender bond is in place however, in the event of the contractor falling through, the supplier would be awarded the value of the bond as a penalty against the contractor.
Performance Bonds guarantee that a product will be of a certain standard and a penalty is payable if they are not. This will usually be issued when a Tender Bond is cancelled. The Bonds act as financial guarantees and have no warranty that a bank will complete on a contract in the event that the customer fails to do so. A performance bond is usually issued by a bank or insurance company to guarantee satisfactory completion of a project by a contractor. When there is a task where a payment and performance bond is required then it will need a bid bond, to initially bid for the job. At the point where the work is awarded to the winning bid, a payment and performance bond will be needed as security of the job completion.
This will provide protection to the Buyer when an advance or progress payment is made to the Seller prior to completion of the contract. The Bonds undertake that the Seller will refund any advance payments that have been made to the Buyer in the event that the product is unsatisfactory. This is typical in large construction matters where a contractor will purchase high-value equipment, plant or materials specifically for the project. The bond will protect in the event of failure to fulfil its contractual obligations e.g. due to insolvency. They will usually be on-demand bonds, meaning that the value set out in the bond is immediately paid on a demand, without any need for preconditions to be met. This is in contrast to a conditional bond where there is only liability if there is a breach of contract (or certain event has occurred as set out in the bond).
These provide a financial guarantee to cover the satisfactory performance of equipment supplied during a specified maintenance or warranty period. The undertaking is by a bond issuer to pay the buyer an amount of money if a company’s warranty obligations for products that are provided are not met and the amount will often be a stated percentage of the export contract value. A warranty bond may be conditional or unconditional. If conditional, it may be a condition of the contract that a warranty bond is purchased before a buyer makes the final payment. In the event that obligations are not met, the buyer can call the warranty bond (requesting payment). The bond is returned by the buyer at the end of the warranty period if the product that is provided has met the specifications.
A surety is a promise or agreement made by one party that debts and financial obligations will be paid. In effect, a surety acts as a guarantee that a person or an organization assumes responsibility for fulfilling financial obligations in the event that the debtor defaults and is unable to make payments. The party that guarantees the debt is referred to as the surety or the guarantor. Sureties can be made by issuing surety bonds, which are legal contracts obligating one party to pay if the other fails to live up to the agreement.
- A surety is a promise that financial obligations will be met
if one party defaults.
- A surety is made by a person or party that takes
responsibility for the debt, default, or other financial
responsibilities of another party.
- Sureties are used in contracts in which one party’s financial
holdings or well-being are in question and the other party wants
a guarantor.
- Surety bonds tie the principal, the oblige (often a government
entity), and the surety.
A guarantee is issued by a bank on the instruction of a client and is used as an insurance policy, to be used when one fails to fulfil a contractual commitment. A financial institution issuing a Letter of Credit will carry out underwriting duties to ensure the credit quality of the party looking for the Letter of Credit before contacting the bank of the party that requests the Letter of Credit. Letters of Credit are usually open for a year. The Letter of Credit is usually requested by the buyer and can be redeemed on demand if there is no payment by the Buyer on the date specified as set out within the contract. The cost of a letter of credit is usually between 3.5-8% of the amount stated per year. The letter can be cancelled when the terms of the contract have been met.