Contract Bonds in International Agreements

What is a contract performance bond and how does it differ internationally?

In the last few years there has been an explosion in the number of bonds that have been requested for contracts, especially construction contracts, in the international market. These types are almost always titled "performance bonds" and are a requirement prior to getting any payments under the contracts. The prerequisites for getting a surety to write these are very strict and can take many companies by surprise, especially those that are used to requirements in the United States.

How is a contract bond different abroad?

The first thing to understand is that a bond in international agreementss may not be the same as one here in the states. Many of these are really "on-demand" types instead of "default" bonds. This is a very important distinction, which we will get into in the following.

So, what's the difference? A demand bond is just that. The obligee simply has to make a demand and then the surety has to pay on that demand. There is no ability of the surety to investigate the claim prior to payment to see if the claim is valid. Instead, the surety would have to make a bad faith claim against the obligee after payment, which makes recovery very difficult. Compare that to a standard default contract bond. The standard type in the United States is this default type. What happens here is that the obligee makes a claim that the obligor has defaulted in some way as to a term in the agreement (such as they haven't completed a phase of the construction job per agreed upon timelines, haven’t completed a job at all, or haven't paid their materials vendor, etc.). Then, the surety gets the claim and investigates that claim to determine whether it is valid and deserves to be satisfied (believe it or not, sometimes claims aren't valid, they are simply disputes between the parties as to some misunderstanding in the written contract). If the claim is determined to be a valid claim, then the surety can decide to hire another contractor to complete or fix the job, or pay the bond amount.

An example on the difference

Let's assume that there is a $1 million performance bond on a contract insurance agreement. Next, let's assume that the contractor has finished half of the project and then has to walk off the job. If this was a demand bond, like we see in international contracts, then the surety would be obligated to pay $1 million. But on a default kind, the surety could hire another contractor to finish the work for $500,000. This is a massive savings versus a demand type.

How do you tell if a contract bond is really a demand bond?

You should really look at how it is structured. If the structure of the surety requires the payment be made to a qualified bank in the local jurisdiction, then it is likely a demand bond. The basis for this requirement is for quick and certain payment of the demand. The other part to review is the default provisions in the agreement. For a demand type written insurance agreement, they generally have several sections on what constitutes a default. However, they generally do not require a default prior to payment. This is a key consideration in determining whether it is a default bond.

Conclusion

Many companies are now seeing performance bonds used regularly in contracts both here in the United States as well as internationally. International ones are tricky as they may be different in that they are demand bonds, which require payment upon a request from the obligee and not any kind of default under the agreement. There is a lot more risk that is placed upon the insurance surety company and due diligence is a necessity by all parties involved. It's never been more important to work with a reputable company that knows all the finer details of both domestic and international law concerning contract insurance agreements. One such company is Swiftbonds. You can learn more about them here.

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