Performance bonds are not sought by the State under Public Private Partnership (PPP) contracts. However those providing finance to the Special Purpose Vehicle (SPV) seek security which may include performance bonds as well as other financial securities.
Previous PPP contracts which used the National Development Finance Agency (NDFA) standard template Project Agreement included the provision of an “Authority Bond”. This bond is called upon in the event that the project is terminated during construction as a result of a default by the SPV and is intended to cover the costs to the Authority of re-tendering the project. The bond is required to be kept in place until a proportion of the works (usually about 25% of the value) is completed. The bond is purchased by the SPV and appears as a cost to the Authority in the tender price.
The requirement for the Authority Bond has been removed from the recently advertised Schools PPP Programme after a value-for-money assessment by the NDFA. The NDFA is satisfied that sufficient remedy remains available under the contract to protect the State’s interests in the event that the contract is terminated owing to a SPV default. Removal of the requirement for the bond is expected to reduce tender prices.
There are no other bonding requirements from the State within the PPP contract. Instead, the SPV is at risk of financial deductions from the stage payments due under the PPP contract for any poor performance during the service period. There is no proposal to alter these terms in the contract as they form an essential part of the risk-transfer mechanism.
Performance bonds are financial securities taken out by construction clients (public or private sector) to insure the contract performance against a default or breach by the contractor. They are provided by specialist insurance companies (sureties). In the case of a default or a breach of contract, the surety undertakes to cover any additional costs up to the value of the bond incurred by the construction client in completing the project. The premiums for the bonds are paid for by the client whereas security may be required by the surety from the contractor in addition to any premium paid. The current cost of the premium can vary from 1.5% – 3.5% of the contract sum.
On foot of concerns expressed by many in the industry over the difficulty in obtaining performance bonds on public works contracts, officials from my Department met with representatives of the construction industry, sureties and representatives of public sector contracting authorities in January of this year.
During that engagement it became apparent that sureties were unwilling to continue to provide bonds at the levels traditionally sought by contracting authorities because of the increased level of insolvencies in the construction sector. This was contributing to substantial delays and uncertainty in awarding contracts because the sureties were unable to meet the requirements set out in the tender documents which were based upon guidance set out in the Capital Works Management Framework published by my Department.
In response to this uncertainty and having considered the options available, Circular 07/13 was issued on 1 May 2013 reducing the level of performance bonds sought on public works contracts to 12.5% for contract sums up to €10 million and 10% thereafter. Previously levels of 25% on projects up to €2.5 million were sought dropping down to 12.5% and 10% on projects with a value in excess of €12.7 million.
Whilst it is expected that there will be a reduction in the cost of premiums to the State it is acknowledged that this may expose the State to greater losses in the event of insolvency due to the reduced level of bond provided. To address this concern the Government Contracts Committee for Construction will shortly publish enhanced guidelines for the financial appraisal of works contractors to ensure that those who are awarded public works contracts have sufficient financial capacity to see a project through to completion. Guidance will also follow later in the year on the appointment of replacement contractors to provide greater certainty to contracting authorities when insolvency occurs on a public works contract.