Parent Company Guarantees and Performance Bonds
17 Jan 2014
When letting large contracts there is often the need to consider the client’s interests in case there are performance or liquidity problems with the appointed contractor.
Two commonly used tools to protect this interest are the Parent Company Guarantee (PCG) (or Parent Company Indemnity as it is sometimes known) and the Performance Bond (PB). So what are the differences between the two and which is most appropriate in any given situation?
Lets look at the two options and then compare and contrast them.
Parent Company Guarantee
A PCG is an undertaking given by the parent company where the Contractor is a subsidiary of a larger company. The parent company undertakes to guarantee the due and proper performance of the contract generally – this means that if the Contractor fails to perform the contract in any respect the parent company can be held responsible as well as the Contractor (its subsidiary).
If the subsidiary should cease trading the parent will indemnify the Client from all losses and damage resulting from the non-performance or improper performance of the Contractor’s obligations.
If the parent company and Contractor go into liquidation at the same time the Client can be left without any recourse to be compensated.
The PCG provides the Client with a second party to hold responsible if the Contractor should fail to perform its obligations.
A PB is an insurance taken out by the Contractor, usually at the Client’s expense. This introduces a third party who is external to both the Client and the Contractor. The Bond assures the Client that if the Contractor should fail to perform the duties under the contract the Client may recover losses from the Bond provider (usually an insurance company or bank). Bonds are usually limited in value and are typically for 10% of the contract value.
It should be noted that there are two forms of PBs, the usual ‘adjudication bond’ where the Client has to prove the default of the Contractor, and a less common, and potentially problematic (for the Contractor) ‘on demand bond’. In an ‘on demand bond’ the client is not required to prove a default on the part of the Contractor, it is simply necessary to call in the bond.
Compare and Contrast
Firstly, a PB is a form of insurance and is provided by an external third party. The fee for the bond is usually charged to the Client and is an immediate contributor to the cost of the contract. A PCG is provided by the Contractor’s parent company and there is no corresponding charge to the Client unless the Contractor should choose to introduce an administration fee (but if he is alone in doing so it will of course affect his competitiveness). In the case of a PB the Client needs to consider carefully whether the benefits of the Bond outweigh the costs involved. This will be dependent on the level of cover, but also the nature of the works specified, an assessment of the Contractor and a number of other matters such as the Client’s appetite for risk!
The extent of the protection will differ between a PB and a PCG. In the former, as has been said, the cover is limited in the bond agreement. The level of cover may not be enough to cover the cost of delays due to appointing a replacement contractor and multiple problems can quickly exhaust the level of cover provided. Often in projects there is more than just the costs to be considered, there is also reputation and goodwill. A PCG will provide the Client with the same level of cover as if the Contractor himself was being held responsible. Typically the Contractor will go into liquidation – at that stage the parent company will be responsible as though he were the original contractor (provided he hasn’t also gone into liquidation – and that is a real possibility).
This last point is particularly important. If the parent company and Contractor go into liquidation at the same time the Client can be left without any recourse to be compensated. It is for this reason that clients often seek both a PCG and a PB. If there is no charge for a PCG and all bidders are required to provide a PB then the Client gets maximum cover for no additional cost.
The final difference is the period of liability under the two arrangements. A PB will usually last throughout the contract period and for a limited time after practical completion as allowed in the contract; a PCG will place the parent company in the same position as the Contractor and this will usually mean that the parent company remains responsible for 12 years following practical completion.
During periods of business uncertainty the availability of bonds to smaller businesses may reduce (or the cost may increase to reflect uncertain times). Clients should therefore think carefully about the need for bonds.
Some parent companies have a policy of not providing PCG and Clients need to consider how to handle such situations carefully.
As has been discussed above, ‘on demand’ PBs have a significant advantage to Clients and may be considered quite dangerous for Contractors.
If the Client makes it necessary for bidders for work to include a PCG, or a PB where there is no parent company, the playing field will not be level so far as costs are concerned.
Clients also need to consider that not all bidders will have parent companies and how they will safeguard the contract in these circumstances – here a PB may seem appropriate but consider how you balance this against those from whom you ask for a PCG.