Part of the QS & Construction Standards RICS Professional Guidance, UK Construction security and performance documents 1st edition, guidance note rics.org/guidanceConstruction security and performance documents RICS guidance note 1st edition (GN 101/2013) (9 RICS‘Acknowledgment (Cover image © IStockshoto/oos 1 work (mage no. 7829495), Pbshed by the Royal Isttution of Chartered Surveyors (FICS) Surveyor Court Westwood Business Park Coventry CVE BIE UK vr losbooks com No esporstity for loss or damage caused to ary person acting or roaring fom action as a rest of the rater included inthis poblcation can be accepted by the authors or RIGS Produced by the Bulcing Surveying Group of tho Royal Inettzion of Charred Surveyors ISBN 978 1 76321 0008 © Royal rsttuton of Chartered Survoyrs FICS) May 2013. Copyright in al r part of this publication rests wih FICS, No pat of tis ‘work may 86 reproduces or used nary form or by ary maane insucing raphe, eloevone, oF mechanical, ndudng photocopying. recording, taping or Web dsbuion, wktiou the writen persion ofthe Poy Inston of Chartered Surveyors o in Ino wath the res ofan easing losnse “Typeset in Great Bran by Columns Design XML Lid, Roading, Becks i CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTSContents ‘Acknowledgments RICS guidance notes Introduction 1 General principles (Level 1 - Knowing) iv 1 3 4 1.1 Introduction 4 1.2 Parties to a project 6 1.3 Interested third parties 8 4.4 Construction security and performance documents 9 2 Practical application (Level 2 ~ Doing) 16 2.1 Introduction 16 2.2 Parent company guarantees 16 2.3 Bonds 7 2.4 Collateral warranties 20 2.5 Third party rights 22 2.6 Direct agreements 23 2.7 Payment security methods 24 3 Practical considerations (Level 3 - Doing/Advising) 26 3.1 Introduction sed 3.2 Parent company guarantees ~ items for consideration 26 3.3 Bonds - items for consideration 27 3.4 Collateral warranties - items for consideration 29 8.5 Third party rights - items for consideration 32 3.6 Collateral warranties/thitd party rights and latent defects insurance 33 3.7 Direct agreements — items for consideration 33 3.8 Payment security methods — items for consideration, 34 CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | iliAcknowledgments RICS would like to thank the following for their contributions to this guidance note: Technical author Kevin Greene (K&L Gates LLP) Black Book Working Group Chair: Andrew Smith (Laing O'Rourke) John G Campbell (BAM Construction Limited) David Cohen (Amicus Development Solutions) ‘Stuart Earl (Gleeds Cost Management Limited) Christopher Green (Capita Symonds Ltd) Jim Molloy (Department of Health, Social Services and Public Safety NI) Roy Morledge (Nottingham Trent University) Michelle Murray (Turner & Townsend plc) ‘Alan Muse (RICS, Director, Built Environment Professional Group) lichael T O'Connor (Carilion Construction Limited) Kevin Whitehead (McBains Cooper Consulting Limited) RICS would also like to recognise the assistance of the following members of K&L Gates LLP in the Grafting of this guidance note: Cathy Harris Laura Ludlow amie Olsen David Race iv | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS.RICS guidance notes This is a guidance note. Where recommendations are made for specific professional tasks, these are intended to represent ‘best practice’, i.e. recommendations hich in the opinion of RIGS meet a high standard of professional competence. Although members are not required to follow the recommendations contained in the note, they should take into account the following points. When an allegation of professional negligence is made against a surveyor, a court or tribunal may take account of the contents of any relevant guidance notes published by RICS in deciding whether or not the member had acted with reasonable competence. In the opinion of RICS, a member conforming to the practices recommended in this note should have at least a partial defence to an allegation of negligence if they have followed those practices. However, members have the responsibilty of deciding when it is inappropriate to folow the guidance. It is for each member to decide on the appropriate procedure to follow in any professional task. However, where members do not comply with the practice recommended in this note, they should do so only for a good reason. In the event of a legal dispute, a court or tribunal may require them to explain why they decided not to adopt the recommended practice. Also, if members have not followed this guidance, and their actions are questioned in an RICS disciplinary case, they will be asked to explain the actions they did take and this may be taken into account by the Panel. In addition, guidance notes are relevant to professional competence in that each member, should be up to date and should have knowledge of guidance notes within a reasonable time of their coming into effect. ‘This guidance note is believed to reflect case Jaw and legislation applicable at its date of publication. itis the member's responsibilty to establish if any changes in case law or legislation after the publication date have an impact on the guidance or information in this, document. It is the member's responsibility to be aware of changes in case law and legislation since the date of publication. Document status defined RICS produces a range of professional guidance products. These have been defined in the table below. This document is a guidance note. CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 1Type of document __| Definition Status | Standard International Standard | An international high level principle based | Mandatory standard developed in collaboration with other relevant bodies Practice Statement RICS practice Document that provides members with Mandatory statement mandatory requirements under Rule 4 of the Rules of Conduct for members Guidance RICS Code of Practice | Document approved by RICS, and endorsed | Mandatory or by another professional body/stakeholder —_| recommended good ‘that provides users with recommendations | practice (will be for accepted good practice as followed by | confirmed in the conscientious practitioners document itself) RICS Guidance Note _ | Document that provides users with Recommended good (@N) recommendations for accepted good practice practice as followed by competent and conscientious practitioners. RICS Information Paper (IP) Practice based information that provides users with the latest information and/or research Information and/or explanatory commentary 2 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTSIntroduction This guidance note reviews security and performance documents normally associated with a construction project. In general terms, these are documents required as security for performance of one sort or another (whether payment, design, management or construction) Jina project. In complex projects, there may be many different types of security and performance documents required by several parties. This guidance note will review the main types of security and performance documents, the parties to them, their purpose and general terms. It begins with a discussion of the general principles (Level 1 - Knowing), is {followed by a review in more deta of the nature and purpose of construction security and performance documents (Level 2 - Doing) and ends with a consideration of practical ‘matters that can arise (Level 3 - Doing/ Advising). ‘CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 3.1. General principles (Level 1 — Knowing) 1.1. Introduction 1.1.1 Many construction projects, no matter what their size, have a potentially complex structure of contractual relations and multiple parties. The payment paths can be wide- ranging ~ from employers to contractors and from contractors down the supply chain to ‘sub-contractors and suppliers. Cash flow life blood of the construction industry and keeping payments flowing is essential. The performance of payment obligations on all sides is, therefore, of fundamental importance and involves a consideration of how such performance can best be secured and risks of non-payment minimised as far as possible. the 1.1.2 The employer may enter into development and funding obligations with third parties, such as funders, purchasers and tenants. Many employers receive funding from different sources, such as banks and building societies. These funders will require ‘construction security’ documents to be in place to help protect their loans and before ‘they will release funds. The project may be let or sold (before, during or after construction) to purchasers and tenants. When taking an Interest in a new, recently built or recently refurbished property, such purchasers and tenants will also want construction security. Funders, purchasers and tenants are likely to require a contractual connection with those responsible for the design and construction of the project in order to protect their position. This would be necessary, for example, in the ‘event of defects manifesting themselves at a later date after occupation or acquisition by tenants or purchasers, or if funders wish to step into the position of the employer if the ‘employer becomes insolvent or otherwise defaults. In the absence of such a contractual connection, itis unlikely that these third parties would be able successfully to claim against parties responsible for the defect or, in the ccase of a funder, to step into the position of the employer in order to complete the project. 1.1.8 A contractual connection is required because a basic rule of contract law is the doctrine of ‘privity of contract’. This doctrine provides, as a general principle, that only a party to a contract can take the benefit of that contract. Many parties are involved in the design, management and construction process and an employer will almost always enter into formal, written contracts with the members of its design and management team and the contractor employed to carry out the works. These contracts will deal with the services and works the team and the contractor are required to camry out, how they are paid and so on. Third partes (such as funders, purchasers and tenants) do not enter into these contracts (indeed some of these third parties may not ‘even be identified at the time such contracts are entered into). However, if a consultant or contractor makes a mistake during design or construction, and a defect in the completed building arises as a result, a funder, purchaser (tenant might suffer financial loss (e.g. the cost of rectifying the defect, the cost of finding alternative accommodation while the defect is rectified, loss of interest and rental income, etc). In general terms, the doctrine of privity of contract means that, in the absence of any contract with those responsible for a mistake, the funder, purchaser or tenant, would not be able successfully to claim in contract to recover such loss. Further, as the law currently stands, it would be very difficult (if not impossible) for a funder, purchaser or tenant to recover their losses from the consultants and contractor on a ‘non-contractual’ basis, such as under the law of tort (essentially negligence). Figure 1(@) illustrates the doctrine of privity of contract. 41 CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS.Figure 1- (a) Dactrne of privity of contrat (Collateral wa Figure 1] ~ Doctrine of privity of eontract tes and fc) Tied party chs Figure 18) -Collatral warranty Figure tf) = Third party rghts a a 1.1.4 A collateral warranty (sometimes also called ‘a duty of care deed’) has been, and remains, one of the ways of overcoming these difficulties. A collateral warranty is a binding contract between a third party with an interest in the project under construction or in the completed project (such as a funder, purchaser cr tenant) and a party who was involved in the design, management and/or construction of the project. A collateral warranty would allow a third party to make a claim against, for example, a structural engineer, if the engineer's design fell below a required standard of skill and care and/or a contractor, if the building was built defectively In order for any claim to be successful under a collateral warranty, as in any contractual claim, the third party would have to show that it sutfered loss as a result of the defective design and/or workmanship. Figure 1(b) shows, in simple terms, the use of a collateral warranty. 1.1.5 The general rule under the doctrine of privity has been fundamentally changed by the Contracts (Rights of Third Parties) Act 1999 (the TPR Act). In short, the TPR Act provides that a third party (such as a funder, purchaser or tenant) may in its own right enforce a term, or terms, of a contract if such contract expressly provides that it may do so or purports to confer such a benefit on it. In this manner, such third party rights allow a third party to make a claim against any consultant or contractor for defective design and/or workmanship in much the same way as under a collateral warranty. In the example set out in paragraph 1.1.4, the third party would be able to make a claim against the structural engineer and/or the contractor, even in the absence of a collateral warranty, provided that the structural engineer's, appointment and building contract effectively provided that the third party could, in its own right, enforce the terms of such appointment and contract. In other words, the third party ccan, in those circumstances, take the benefit of the terms of a contract even in the absence of a direct contractual link (the TPR Act thereby creating an exception to the privity of contract, doctrine). Figure 1(¢) illustrates the use of third party rights. While third party rights are being increasingly adopted in UK development projects, collateral warranties are still widely CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 5used. This balance, however, is changing as the construction industry becomes more familiar, and comfortable, with third party rights. 1.2 Parties to a project A development project often comprises the following parties: © funders © employers/developers © professional consultants, such as architects, engineers (structural and mechanical and electrical), quantity surveyors, cost consultants, CDM co- ‘ordinators and project managers. Sometimes this team will be augmented by specialist consultants, such as acoustic ‘consultants and sustainability consultants © contractors; and © sub-contractors. 1.2.1 Funders (@) Funders are parties who lend money in connection with a project, usually banks, building societies or other similar funding institutions. However, certain institutional investors, such as pension funds or life assurance companies, fund projects and are typically referred to as ‘funds’. An employer (likely to be referred to as a developer) and a fund of this nature may exchange contracts for the sale of the completed property at an early stage of the development process (such as when the works are partially complete or even before they have started), a so-called ‘forward purchase’. The fund does not agree to provide construction finance but will pay the purchase price when the project is completed. In contrast, certain funds may (in what is known as a “forward funding’ arrangement) provide finance to the employer to cover the cost of the project as it progresses during the development phases (including the costs of the contractor and the consultants). In such an arrangement, the fund is likely to purchase the land at the outset, before development commences. For the purposes of this guidance note, funders are parties (such as banks and building societies) who lend money in the more traditional bank lending sense, although the funds in forward purchase and forward funding transactions may also require construction security documents similar in nature to those required by funders. (b) Funders will want to be comfortable that their involvement will be satisfactory from a financial point of view but also that, if matters do not go according to plan, they are as well protected as possible. (©) There is likely to be a lengthy facility, o funding, agreement between the funder and the employer (the borrower). The funder will be concerned to cover the position where the employer gets into financial dificulties. The risk of contractor, principal sub-contractor or consuttant insolvency is normally left with the employer. (@) If there is an employer defauit (financial or otherwise), a funder will wish to have arrangements in place from the outset that enable it to take over the project itself, or through an appointed third party with comparable skills to the employer, in order to complete it (sometimes referred to as ‘building it out) This is to achieve completion of the project with the minimum of extra expense, disruption and delay that will inevitably occur in these circumstances. 1.2.2 Employers (@) The employer is the party for whose benefit the project is carried out. An employer is often referred to as a client, developer or promoter, depending on the context. (0) The employer will (with relevant members of its team) appoint the consultants, choose the contractors, agree the terms of the building contract (including the contract sum) and then arrange for these parties to be paid. (©) The employer is particularly interested to ensure that the project succeeds - that costs come within budget and that the project meets expectations relating to quality, health and safety and programme. The employer may want to let and/or sell the completed project (in whole or in part) and it may have borrowed money from funders to pay for the works. The 6 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS:employer will want to ensure that all third party security and performance documents are in place (or can be put into place) so that the conditions of any letting, sale and funding are satisfied. It will also want to ensure that its Position is protected in the event of any serious default by anyone in the contractual supply chain, particularly the main contractor. 1.2.3. Professional consultants (@) The primary roles of the professional consultants engaged by the employer are to design, cost, manage and administer the contracts and the project. They also carry out services relevant to statutory responsibilities, such as obtaining planning consents for the employer and ensuring compliance with health and safety regulations. (0) The employer may be entering into formal, written appointments with each of the consultants. These appointments are likely to be based on those published by the relevant body governing the profession of the consultant (such as RICS, RIBA and ACE) or to be in a bespoke form, i.e. drafted by or on behalf of the employer and tallored for the particular requirements of the project. These appointments will usually include, for example, ‘an obligation upon the consultant to provide collateral warranties and/or third party rights to third parties, such as funders, purchasers and tenants. in some projects, funders will separately appoint independent technical monitors to deal with payments and to check ‘that the project is being carried out properly and not over-running in terms of cost and time. ‘These monitors will generally be professional consultants who will work alongside the consultants appointed by the employer. 1.2.4 Contractors (@) The contractor agrees to carry out the building works in accordance with the drawings and/or specifications and the terms of the building contract agreed with the employer. ‘They may do so themselves or (more usually) employ sub-contractors to carry out some or all of the works. The contractor will be responsible for managing and monitoring the sub-contractors and (as a general rule) for their performance. (0) The contractor may agree to construct the works in accordance with the design produced by the employer and/or their professional consultants - the so-called ‘traditional’ method of procurement. This is illustrated by Figure 2. Figure 2~"Tradtiona’ procurement = os ~ l () Alternatively, the contractor may agree to take on design responsibility under the building contract - the so-called ‘design and build’ method of procurement. This is illustrated by Figure 3. (@ There are other procurement methods but this guidance note concentrates on the types more frequently used. The general principles, however, can be carried through where other methods of procurement are adopted. (€) The employer will most likely enter into a formal, written building contract with the contractor which reflects the chosen method of procurement. The contract may (as with the consultants’ appointments) be in a standard form, such as those published by the JCT or NEC, or may be bespoke (probably an amended standard form) to reflect the requirements of the project. ur 1.2.5 Sub-contractors (@) Main contractors will generally employ sub- contractors to undertake some or all of the design and/or construction of the works. The ‘main contractor will usually take responsibility ‘or the works of their sub-contractors as if they ‘CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS I 7had carried out the works themselves, but the ‘employer and third parties (such as funders, purchasers and tenants) will most probably look for performance security from the main design sub-contractors in the event that the ‘main contractor defaults or becomes insolvent. (b) The sub-contractors may enter into formal, written sub-contracts with the main contractor. ‘These may be in a standard form (such as the CT and NEC forms) or an amended standard form. The sub-contract will usually be a ‘low down’ of the relevant obligations placed upon the main contractor. For example, if the main contractor has to obtain collateral warranties or third party rights from certain sub-contractors in favour of third parties, this obligation should bbe passed down by the main contractor to those sub-contractors by way of inclusion in the relevant sub-contracts. (6) There may be specialist suppliers who are contracted to supply goods and materials to the contractor and/or sub-contractors, such as ductwork and cladding suppliers. It would be unusual to have collateral warranties or third party rights from such suppliers as Build’ procurement cs I =—= cs responsibilty for their goods and materials is usually assumed by the contractor or sub- contractor incorporating them into their works. ‘There may, however, be product guarantees. and warranties relating to the quality of such goods and materials given by the supplier, ‘which are available to the owner of the completed project. Such product guarantees. and warranties are not discussed in this, ‘guidance note. 1.3. Interested third parties ‘An employer will often finance the project with ‘outside funds. An employer may wish to develop the project for their own use or with a view to selling and/or letting it (or parts of It). Such funders, purchasers and tenants all have {an interest in the outcome of the project. For the purposes of this guidance note, they will generally be referred to as ‘interested third Parties’ or ‘interested third party beneficiaries’. Figure 4 illustrates the inter-relationship between various interested third parties on 8 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTSFigure 4 Interolationship betweon intrested third partioa ona project Emr ee cacas traditional and design and build procurement methods in a typical project. 1.4 Construction security and performance documents 1.4.1 General {@) When taking an interest in a construction project, interested third parties usually require ‘some form of construction security. This ‘security may be available over, or alongside, ‘the rights to enforce some of the terms of the contracts between the employer and those ‘who are designing, managing and/or constructing the project. it may allow a party with an interest in the project to exercise rights that they would not otherwise have. For example, it is specifically in relation to the area of employer defauit that potential problems arise for a funder in funding a project. In order to safeguard the investment a funder has made, the funder will want to have in place ‘arrangements that enable them, in the event of serious default by an employer, to take over the ‘whole project themselves, or possibly through fw . Per) Seen) Ceres ec) Cee sioat ‘an appropriately qualified third party appointed by the funder. This is to ensure that they can build out and secure completion of the project with the minimum of disruption and delay (and ‘extra cost). Such arrangements are usually called ‘step-in rights’. In effect, these rights create an express contractual right for the benefit of the funder, and form part of their security package for the loan to the employer. (6) In addition, credit risk in the construction justry is high, particularly as the construction supply chain often operates on unsecured credit. t may be necessary, therefore, to ‘consider the manner in which insolvency risks (cf the employer as well as the members of the supply chain) can be dealt with. (©) Construction security and performance documents typically used in a construction project are: parent company guarantees bonds collateral warranties third party rights direct agreements; and payment security methods (such as escrow accounts and project bank accounts). ‘CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 9(@) Figure 6 illustrates the relationship between various parties on a typical project providing or receiving the benefit of parent company ‘guarantees, bonds and direct agreements. Figures 6a and 6b illustrate typical arrangements between various parties giving or receiving the benefit of collateral warranties or third party rights. Each project will have different requirements; it is not possible, within ‘this guidance note, to examine all of the different permutations of the security documents that might be used. Figure 5 ~ Security and performance document ilustrating ‘parent company guarantees, bonds and drect agreements 1.4.2 Bonds and guarantees - an introduction {@) Its important to understand basic legal principles relating to bonds and guarantees, which are forms of security often used in the construction industry. Bonds and guarantees have much in common but there can be a degree of misunderstanding about what each type of security is intended to achieve. This is not least because of the numerous descriptions. given to them, such as ‘on demand bond’, ‘conditional bond’, ‘default bond’, ‘guarantee’, “performance bond’ and ‘parent company guarantee’. The description of the document itself may not be conclusive of the type of legal effect it actually has. Issuers of bonds and ‘guarantees are variously described as ‘obligors', ‘bondsmen’, ‘sureties’ or fread Con eens I; Ce euene | eet) a ‘guarantors’. For the purposes of this guidance note, they are referred to as bondsmen or guarantors. Those receiving the benefit of bonds and guarantees are often called ‘obliges’ or ‘beneficiaries’. They will be referred to as beneficiaries within this guidance note. (&) Itis important, in this context, to make a distinction between primary and secondary obligations: © Apprimary obligation is (in the context of a bond or guarantee given to an employer) an Undertaking from a bondsman to pay a sum of money to the employer without reference to the liability of the contractor. An example is where A promises to pay B up to £1 milion if B (simply) asks A to do so, in writing. This is in the nature of an ‘on 10 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTSFigure 6a ~ Collateral warrantlaanhird party rights and traditional’ procurement Figure 6b - Collateral warrantles/third party rights and ‘design & bully’ procurement Z Geen onetenicy demand’ bond. The more commonly used ‘type of on demand bonds in the UK are advance payment, tender and retention bonds (which are discussed at paragraph 1.4.4(0). However, on demand bonds are often used in PF/PPP projects in the UK. ‘Such bonds are usually of a conditional rang xa =a aro a ood Tenant(s) nature in that they follow an on demand format but are subject to the condition that any demand has to be accompanied by an adjudication award. In other words, the bondsman would have to pay where liability is established following adjudication proceedings. On demand bonds are also ‘CONSTRUCTION SEQURITY AND PERFORMANCE DOCUMENTS | 111used in certain international projects; again, these may be of a conditional nature, usually by reference to a statement or certificate from the engineer or contract administrator that the contractor is in default. ‘® A secondary obligation is (again in the context of a bond or guarantee to an employer) one where its enforceability is dependent on a breach by the contractor of ‘the underlying building contract in favour of ‘the employer. This is in the nature of a suretyship, or guarantee, obligation. If the employer cannot establish a breach by the contractor, then the bondsman has no liability to pay. It is this principle that Uunderpins the default, conditional or performance bonds, which are the ‘commonly used forms of bond in UK construction projects. (€) Bonds and guarantees provide a form of financial recourse in the event of risks ‘occurring. In construction projects, bonds and guarantees are typically used as security for performance of the contractor but bonds and guarantees are increasingly provided as an alternative to retention monies and also as security for the employer's performance (2. payment). Where used as security for the contractor's performance, bonds are often treated as an alternative to a parent company guarantee, when in fact they are very likely to have different legal effects and provide different remedies. (4) As a general point, the terms of any legal document (such as a bond or guarantee) must be examined very carefully in order to ascertain its effect. In particular, in the event of a claim, detailed consideration ought to be given to the circumstances in which any claim can be made and the precise requirements of any notice to be served, such as the form of the notice, the information to be provided within it, accompanying documents, the time for servi the correct address for service and so on. 1.4.3 Parent company guarantees (@) A parent company guarantee is a contract between a parent company and a third party beneficiary by which the parent (as guarantor) ‘guarantees the performance of one of the subsidiaries. A ‘parent company’ may be a misnomer; the company giving the guarantee may be the ultimate holding company or ‘another company within the group of companies of which the subsidiary forms a part. (0) In the context of a typical project, this will ‘most likely mean a parent company of the contractor guaranteeing to the employer the performance of the contractor under the building contract. A parent company guarantee is often expressed (in its simplest form) as ‘A (the parent company) promises to B (the employer) that C (the subsidiary company) will perform their contract with B' and this is in the nature of a secondary obligation. However, could also mean a parent company quaranteeing the payment obligations of an ‘employer, as the subsidiary company, to a contractor under a building contract. As mentioned above, each document must be reviewed carefully to examine its correct legal effect. A guarantee, including a parent company guarantee, may seek to create a primary obligation, so that the guarantor is ‘equally liable with the contractor and, therefore, the beneficiary of the guarantee may look to either for performance of the primary obligation. 1.4.4 Bonds (@) In general terms, bonds are undertakings given by one party — a bondsman - to another to pay money if a third party defaults. (0) Bonds are regularly procured by contractors in favour of employers, as security for losses caused to employers by a contractor default {the intention being to include insolvency). However, they may be procured by contractors in favour of employers in other instances, such as to cover advance payments, retention ‘monies and tender costs. (6) A bond will normally be required by an ‘employer as a condition of entering into a building contract with the contractor. In the UK market, a commonly used form of bond is a performance bond. This is generally a default bond where the bondsman’s liability is 412 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTSsecondary to that of the contractor, unless and until the contractor defaults. Such a bond often provides that before the bondsman is liable, the employer (as beneficiary) must demonstrate that the contractor has failed to comply with the relevant obligations under the building contract and that the employer has suffered loss as a result. Insolvency itself is not a default and, if the ‘employment of the contractor is determined as a result of insolvency (as most building contracts provide), the contractor's failure to complete the works is unlikely to constitute a defauit and the insolvency itself is not a breach of contract. As most forms of building contract provide for termination of the employment of the contractor in the event of insolvency, without making insolvency itself a breach, consideration should be given to insolvency being addressed expressly within the terms of the bond, so that the employer should be entitled to make a claim under the bond in such an event. (@) A bond would normally have a financial timit ‘on the bondsman’ liabilty typically up to ten per cent of the original contract sum) and a ‘time limit within which a claim under it could be made (e.g. before practical completion or completion of making good of defects). (@) On international construction projects, employers often require security for performance in the form of a primary obligation from the contractor's bank. This may be in the form of an on demand bond where a bank (as bondsman) is liable to pay on receipt of, for ‘example, a simple statement (usually from the architect/engineer) that the contractor is in default of the underlying construction contract. ‘These bonds are ‘conditional on demand bonds’; while they impose conditions, they place little extra burden on the employer and should not take away from the fact that, essentially, they are on demand bonds. As mentioned previously, these bonds are relatively uncommon in the UK but can be seen in use in some UK PFUPPP projects where ‘adjudication bonds’ are provided, i.e. bonds which are payable on demand but on condition of receipt by the bondsman of an adjudication award. (9 On demand bonds tend not to be popular in the UK construction industry. Once the demand has been made and paid by the bondsman, the contractor (or whoever has procured the bond) then has to recover the payment if itis able to establish that the payment should not have been made or too much was paid. If the employer, as beneficiary, had become insolvent in the meantime, that would be the contractor's risk. There are, however, certain instances where there is a clear monetary risk and where ‘an on demand bond may be appropriate, such ‘as an advance payment, retention or tender bond. In essence, these are: advance payment bond: a bond used when the employer makes an advance payment to cover the contractor's costs for a particular part of the project ¢ retention bond: may be required when there is an early release of retention monies by the employer; and © tender (or bid) bond: would entitle the ‘employer to payment if they have incurred substantial costs in a tender process and the contractor withdraws their tender. 1.4.5 Collateral warranties (@) As explained at paragraphs 1.1.3 and 1.1.4, a collateral warranty is a contract under which ‘professional consultant, contractor or sub- contractor generally warrants to an interested third party that they have complied with thelr professional appointment, building contract or sub-contract. Essentially, it creates a contractual link between the consuttant/ contractor/sub-contractor and the interested third party where one does not already exist. Without such a collateral warranty, an interested third party will have no effective contractual rights against the consultant, contractor or sub-contractor responsible for a defect in the project, or a funder would not be able to exercise a right of step-in, if required. ‘The interested third party would also be Unlikely to be able to claim their losses successfully under the tort of negligence. (©) The forms of collateral warranty are usually annexed to the relevant contract (.e. the appointment, building contract or sub-contract, as appropriate). CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 13.(©) There are likely to be commercial pressures ‘on consultants, contractors and sub- contractors to agree to provide collateral warranties in favour of interested third parties. In other words, if a consultant, contractor or sub-contractor does not agree to give warranties and/or third party rights, that party may not be engaged by the employer (or contractor) for the purposes of the project. In practice, in many development projects involving interested third parties, it would be usual for consultants, contractors and sub- contractors with major design responsibilities to agree to provide collateral warranties (or third party rights), subject to agreement of the manner in which they will be provided and their terms, taking into account the conditions of their professional indemnity insurance policies. 1.4.6. Third party rights {@) As discussed in paragraph 1.1.5, third party rights are similar to collateral warranties in that they aim to provide an interested third party with the same type of construction security. Third party rights allow an interested third party to enforce the terms of a professional appointment, building contract or sub-contract that, otherwise, such a third party could not enforce against the professional consultant, contractor or sub-contractor. The difference is that, whereas a warranty achieves this through a contract which is executed by the relevant parties, third party rights are granted by means of a statute (the TPR Act) to allow such an interested third party to have the benefit of the contractual provisions normally contained in a collateral warranty, without needing a ‘separately executed contract. The interested third party can, therefore, rely on such Provisions rather than have to finalise, print, ‘sign and distribute an additional contract. Third party rights are becoming increasingly more acceptable to most interested third parties (and their provision is generally recognised within industry standard contracts as well as bespoke contracts). However, some interested third parties still prefer to have a written, signed and dated agreement in the form of a collateral warranty. (0) Third party rights are usually specifically set out in the relevant contract (.e. appointment, building contract or sub-contract, as appropriate). They will normally be given to an interested third party by means of a notice issued by the employer to the consultant, contractor or sub-contractor. (6) In practice, parties may exclude the ‘operation of the TPR Act in contracts. If third Party rights are to be given to interested third parties, they must be expressly included in the relevant underlying contract as third party rights available for the benefit of such interested third parties. 1.4.7 Direct agreements (@) On more complex projects, particularly PFV/ PPP projects and other major projects within ‘the public sector, contractors and significant sub-contractors may be required to enter into direct agreements with funders. (0) The purpose of direct agreements is to give the funder the opportunity if the contractor or sub-contractors have a right to terminate their works, to step in, either directly or through a nominee or representative, to remedy the termination event or to substitute a new project company or contractor. Such an agreement creates an opportunity for the funder to complete the construction works and to minimise disruption to the income stream. 1.4.8 Payment security methods (@) Payment secutity (Le. securing the performance of payment obligations under a contract) may take a number of forms including: © Escrow accounts: an account may be opened by an employer into which monies are deposited and can be released to the contractor under certain circumstances (eg. on the issue of payment certificates under the building contract). © Project bank accounts: a bank account opened usually in the names of the project parties into which the employer must make payments in accordance with the building contract. The funds are usually held in trust and released directly to the relevant members of the supply chain in accordance with their contractual entitlements. 14 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS(©) In each case, the intention is to leave the employer as nearly as possible in the same position as if they were simply making payment under the building or other project contract. However, both the escrow account and the project bank account are aimed at providing payment security to the supply chain against Unjustified non-payment by, or the insolvency of, the employer and/or the main contractor. (¢) Other methods of payment security include a direct funder guarantee, an advance payment bong, irrevocable and unconditional letters of credit, or a parent company guarantee from the employer's ‘parent’. ‘CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 15,2 Practical application (Level 2 - Doing) 2.1 Introduction This section looks in more detail at the nature and purpose of certain construction security land performance documents, including the parties that enter into them, an explanation of what these documents are intended to do and a review of general provisions. 2.2 Parent company guarantees 2.2.1 Parties ‘The parties are usually the employer, the contractor and a guarantor. While the most common position is the contractor procuring a parent company guarantee in favour of the ‘employer, to provide protection in the event of a contractor default, in certain instances a contractor may require an employer to procure 2 guarantee of the employer's payment obligations. Ideally, the guarantor should be the Utimate parent company in the group but does not necessarily need to be where an intermediate company is of suficient financial standing to be able to provide the guarantee. ‘This guidance note focuses on the more usual position of a parent company guarantee being given on behalf of a contractor by their parent to an employer. 2.2.2 Purpose In essence, if the contractor fails to perform their obligations under the building contract or becomes insolvent, the guarantor will perform, or be responsible for, the contractor's obligations instead. If the guarantor is the parent company of the contractor, they are required to see to it that the contractor performs and has sufficient funds to perform (although, if a subsidiary is insolvent, it may be the case that the parent is also in financial difficulties). 2.2.3 General provisions (@) The law relating to guarantees is complex and made more difficult by there being many different forms of guarantee. Specialist advice will usually be required. General legal principles relating to guarantees are briefly discussed at paragraph 1.4.2. (0) The guarantee is commonly prepared by or (on behalf of the employer although many contractors will oer their own forms or, more likely, amendments to the employer's form. (©) A key provision will be one stating that the guarantor will perform the contractor's obligations in the event that the contractor becomes insolvent or falls to perform their contractual obligations or will be responsible for losses caused to the employer by defaults of the contractor. There may be conditions to, 7 limitations on, such guarantors liability, ¢.g. that the guarantors liability only arises if and when the contractor falls to perform the guaranteed obligations and then only to the ‘same extent as the contractor. This wording suggests that the guarantee is of a secondary obligation nature but the wording of any guarantee would always have to be carefully reviewed. Many parent company guarantees create a primary obligation, so that the guarantor may be equally liable with the contractor. (6) The guarantee will usually state that the guarantor will not be released from their obligations if there is an alteration to the terms of the building contract or any dispensation allowed to the contractor. (©) There may also be a clause allowing the employer to assign the benefit of the guarantee 16 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS:to another party, e.g. to a funder or a party taking over the employer's interest in the project. ( The guarantee may also includk © ‘no greater liability’ provision, which allows the parent company to use limitations or exclusions of liability which the subsidiary company may have agreed with the employer under their building contract in any claim brought under the parent company guarantee © an expiry date following which the parent company guarantee will cease to be effective (save, as a general rule, for claims made before that expiry date); and © a dispute resolution procedure, setting out the rules and method of resolving any disputes which may arise. Figure 7 illustrates a parent company guarantee arrangement where the obligations of a contractor are guaranteed by their parent in favour of an employer. Fre 7- Pernt company guaranoe ey ee Cor amend Cin ee 2.3 Bonds 2.3.1 Parties ‘The parties are usually the employer, the contractor and a bondsman, which is often the contractor's bank or an insurance company. The bondsman will generally require an indemnity or other security from the contractor before giving the bond. 2.3.2 Purpose In general terms, bonds provide security for performance by the contractor and cover the costs of the employer (up to a financial limit) in the event of a contractor default, such as the additional costs associated with appointing a substitute contractor to complete the works. This guidance note focuses on bonds procured in favour of the employer by a contractor (but sometimes contractors require employers to be bonded to secure the employer's payment obligations). The bondsman undertakes to pay to the employer a sum of money if the contractor fails to perform their obligations under the building contract. The employer often sees the bond as part of their construction security package designed to minimise or reduce the impact of contractor insolvency. Bonds differ from parent company guarantees in that they provide financial compensation in the event that a contractor fails to perform their obligations, whereas a parent company ‘Quarantee is intended to guarantee that the ‘obligations are performed, which may result in financial compensation or, in certain instances, the parent company finishing the works if the contractor is unable to do so. 2.3.3 Types of bond (@) There are a wide range of bonds available; some are drafted specifically for the project but standard forms are also available (such as the ‘model form of guarantee bond published by the Association of British Insurers (ABD) although they tend to be amended by the parties. The negotiations dealing with bonds are often left unti late in the procurement process, The terms of any bond need to be reviewed very carefully (and appropriate advice taken as required). (b) The general legal principles relating to bonds are briefly discussed at paragraph 1.4.2, including the differences in terminology. As mentioned, there are a variety of types of bond, including the following: © Performance bonds: the most commonly used forms of performance bonds in a UK construction project are default bonds issued by a bondsman on behalf of a CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 17.contractor, Le, they are conditional on the proper performance of the building contract by the contractor. If the contractor does not perform their obligations in accordance with the building contract, the bondsman agrees to pay the employer their losses up to a stated maximum sum, often a percentage of the initia contract sum. Figure 8 ilustrates the operation of a performance bond. Advance payment bonds: used when the ‘employer makes an advance payment (sometimes called a ‘down payment’) to ‘cover the contractor's setting up costs or costs for a particular part of the project. There may be good commercial reasons for the employer making such advances, primarily a saving on the contract price. Unless the employer retains some control over the advance, it may be diverted to some other use within the contractor's organisation. The bond, therefore, protects the employer and can be called if the monies advanced are not used for the project. They are generally on demand bonds. Figure 9 illustrates the operation of an advance payment bond. Figure 8 - Performance bond Mri Centers Figure 9~ Advance payment bond 18 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS@ Retention bonds: may be required where there is early release of retention monies or payment under a building contract gross without deduction. These are generally on ‘demand bonds which require the bondsman to pay a sum equivalent to the retention monies, which would otherwise have been retained from payments due Under the building contract. Figure 10 illustrates a retention bond structure. Tender (or bid) bonds: in general, entitle the employer to payment if, after they have spent a great deal of time and expense - negotiating with a contractor, the contractor ‘then withdraws their tender and refuses to contract with the employer, possibly delaying the project and forcing a re-tender. The amount stated in the bond may be a specific sum or a percentage of the tender price subject to a maximum sum. Such bonds are generally on demand bonds but are relatively unusual in domestic UK construction projects. Figure 11 illustrates the structure of a tender bond. Figure 10 ~ Retention bond Sag reteton under (CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 192.3.4 General provisions These will depend on the type of bond being provided. However, bonds will usually contain key provisions setting out the amount of the bond, the circumstances in which a call or a demand under the bond can be made, the procedures which need to be followed when making a call or demand and an expiry date. 2.4 Collateral warranties 2.4.1 Parties Collateral warranties are normally given by contractors, certain sub-contractors and the professional consultants (often called ‘'warrantors') in favour of one or more interested third parties. The employer is also often a party to the warranty document in order to consent to the arrangement. In some instances (usually in a design and build method of procurement), warranties are also given to the employer by the professional consultants employed by the contractor (the consultants are often originally appointed by the employer and their appointments novated (or transferred) to the contractor on or before the commencement of construction, in which event they will normally provide a collateral warranty to the employer) 2.4.2 Purpose A collateral warranty is a contract between a third party with an interest in the project under construction, or the completed project, and a person who is or was involved in the design, management and/or construction of that project. When taking an interest in a new, recently built, or recently refurbished property, an interested third party will usually want to minimise the risk that they will have to pay for the remedy of any problems or defects in that property or project - they want construction security. A funder providing development finance to an employer will also want construction security to help protect their loan. In other words, if something goes wrong on the project, the interested third parties will want to recover any losses from those responsible — collateral warranties should enable them to do so. A funder may also want to be able to step in and build out the project if the employer defaults in some way (e.g. becomes insolvent) before the project is completed. The collateral warranty enables the funder to do this by using step-in rights, although the funder is usually obliged to make good any payments then outstanding to the warrantor before it can exercise those step-in rights. A collateral warranty, therefore, creates a duty and set of rights in contract in favour of the interested third party, which would not otherwise have existed because of the doctrine of privity of contract, which is explained at paragraph 1.1.3. Without such a contractual link, a third party is very unlikely to have any successful right of legal recourse against the party which was responsible for a defect in the design and/or construction of the project (whether in contract or tort). This is explained in greater detail at paragraphs 1.1.3 and 1.1.4 2.4.3 The beneficiaries of warranties Warranties may be given by contractors, sub- contractors and professional consultants in favour of: © the employer (if they have not directly ‘employed the warrantor) funders ‘any purchaser or tenant of the whole and/or any part of a newiy built property ‘once it is completed; and/or ‘© other interested parties, such as freeholders ‘and management companies. 2.4.4 General provisions (@) Warranties usually contain an undertaking {rom the warrantor in favour of the interested third party that the warrantor has performed and/or is performing their works and/or services to the standard required under their primary underlying contract with the employer. For example, a warranty from a consultant might state that the consultant ‘warrants to [the interested third party] that it has performed and will continue to perform the services exercising the reasonable skill, care and diligence to be expected of a competent consultant of the relevant discipline who is experianced in providing similar services in connection with 20 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTSprojects of a similar size, scope and complexity to the Project and otherwise in accordance with the terms of the Appointment’. (0) If the warrantor has any significant design liability, there will usually be an obligation in the warranty that the warrantor should maintain professional indemnity insurance up to an agreed level and for a specified period. The ‘warrantor would normally also be required to provide evidence that such insurance cover in place. () There may be an obligation on the warrantor not to specify or incorporate (or allow to be incorporated) in the works certain prohibited materials. Sometimes these materials are specifically listed in the warranties, or the ‘warranty could simply refer to an agreed materials standard or standards. (@ There may be provisions limiting the warrantor’s liability. For example, there may be a clause limiting the liability of the warrantor to a certain amount (often linked to the level of their professional indemnity insurance cover). ‘There could also be clauses restricting the losses which a third party beneficiary might be able to recover from a warrantor in the event of a claim, e.g. to the reasonable cost of repair, renewal and/or reinstatement of the property caused by the warrantor’s breach (so thal, ‘among other things, loss of rents cannot be recovered). (@) Some warranties may also contain a ‘net contribution’ clause which states that the ‘warrantor’s liability should be limited to such ‘sum as is ‘just and equitable’ (in other words, fain, given its responsibility for the loss or damage suffered and certain stated assumptions. Figure 12 illustrates how a net contribution clause can work. ( A warranty typically includes a ‘no greater liability’ and/or ‘equivalent rights of defence’ clause. A no greater liability clause provides that the warrantor cannot have a greater liability under the collateral warranty to the interested third party than they would have to ‘the employer under the appointment or building contract. An ‘equivalent rights of defence’ clause provides that the warrantor may use any defence that they may have under the professional appointment or building contract to defend a claim from the interested third party beneficiary under the collateral warranty. Figure 12-Net contribution clauses IES Soecratrn nr Pecans ates Pspaban peaeeet CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 21These types of provisions might allow, among other things, a right of set-off, i. the right for the warrantor to set-off the amount of any claim which they may have against their employer (such as for non-payment of fees or for unpaid works) against any claim made by the interested third party beneficiary under a warranty. Such a right of set-off by the warrantor may be expressly excluded by the terms of the collateral warranty, i.e. the warrantor would not in the circumstance be able to put forward a right of set-off in any claim by the interested third party under the warranty. These types of clauses are the reason why an Interested third party beneficiary would very likely want to review the terms of the appointment and/or building contract when negotiating and agreeing the terms of a collateral warranty, because the benefits given by a collateral warranty (or by third party rights) may be limited by the terms of the principal underlying contract itself. This also applies to sub-contracts where sub-contractor warranties are being provided. Copies of sub-contract will (most likely) also need to be supplied to each interested third party beneficiary of collateral warranties or third party rights, with ‘commercial information edited out. (g) When the warrantor is responsible for design, the warrantor will usually retain copyright in their design, but the beneficiary would be granted a copyright licence to use and reproduce design documents prepared by the warrantor for certain purposes. Sometimes, there is not only a provision in @ warranty granting a licence in respect of copyright, but also an indemnity provision indemnifying the interested third party in respect of any claim it may suffer as a result of the warrantor infringing or being held to infringe any copyright. There may also be a provision stating that the warrantor shall not be liable under the collateral warranty for any misuse by the beneficiary of design documents and materials (¢. any use other than that for which such documents and materials were prepared by the warrantor). (hy The beneficiary of a warranty may want the right to assign the benefit of the warranty to another party who takes that beneficiary's interest in the project (and further onward assignments). The warrantor will often seek to limit this right, e.g. by limiting the number of times the benefit of the warranty can be assigned. () Parties providing warranties should normally seek to review their terms with their legal or insurance advisers before they are agreed, since they are long-term obligations. The form of warranty is often agreed in tandem with the appointment or building contract so that, in effect, the warranty represents a document negotiated and agreed between the parties at the outset, often long before the warranty has to be given Figures 6a and 6b illustrate projects where collateral warranties are being given and received by relevant parties. 2.5 Third party rights 2.5.1 Parties A relevant party (contractor, sub-contractor or consultant) agrees in the terms of the relevant underlying contract (.e. the building contract, ‘sub-contract or appointment) to give third party rights to an interested third party. 2.5.2 Purpose Third party rights allow an interested third party to enforce a specific term (or set of terms) in the underlying contract, which that third party would otherwise not have been able to do because they are not a party to that contract. ‘The purpose of third party rights in most UK construction projects is to establish a contractual relationship in the same manner as a collateral warranty. This is achieved by means of statute - the TPR Act - which allows a third party beneficiary to have the benefit of contractual provisions (such as those normally contained in a collateral warranty) without the need for a separate, signed and executed, contract. The background and effect of the TPR Act is described in greater detail at paragraph 1.1.5 22 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS2.5.3 The beneficiaries of t rights party Third party rights may be given by contractors, sub-contractors and consultants in favour of: © the employer (if they have not directly ‘employed the party giving the third party rights) © funders © any purchaser or tenant of the whole and/or any part of a newly built property once it is completed; and/or © other interested third parties, such as frecholders and management companies. 2.5.4 General provisions Third party rights are a set of rights granted by cone party in favour of another (third) party who is not a party to the contract, to enforce certain terms of a contract. Third party rights ‘commonly appear either within a standalone schedule to the building contract, sub-contract, ‘or appointment setting out the terms that an interested third party may enforce, or as a schedule listing the clauses that an interested third party may enforce. There should be a provision within the relevant underlying contract setting out how such third party rights are effectively granted in favour of an interested third party. Usually, this is by means of a notice served by the employer on the party providing the benefit of the third party rights which will identity the interested third party in whose favour such third party rights are being given. Third party rights are similar or equivalent to the general provisions discussed at paragraph 2.4.4 in the context of collateral warranties. Parties giving third party rights will be in the same position as parties providing collateral warranties and will normally wish to review the terms of such third party rights with their legal or insurance advisers before they are agreed. A party receiving the benefit of third party rights would, as in the case of collateral warranties, very likely want to review the relevant contract, under which such rights are purported to be iven. This would not only be because the benefits received under third party rights may be subject to the terms of such contract but ‘also to check the manner in which such third party rights are being conferred on them. Figures 6a and 6b illustrate projects where third party rights are being given and received by relevant parties. 2.6 Direct agreements 2.6.1 Parties ‘The parties are the funder and the contractor ‘and, sometimes, the funder and key sub- contractors. The employer is also usually a party to the agreement to show their consent to the arrangements within it. 2.6.2 Purpose Direct agreements generally allow the funder to step into the shoes of the employer in the ‘event that the employer becomes insolvent or defaults in relation to the loan obligations they ‘owe to the funder under the facility agreement. Funders will usually require direct agreements in relation to the building contract, important sub-contracts and other key agreements used in larger projects, such as operating/facilities ‘management agreements (which operate once the project has been constructed). 2.6.3 General provisions A key provision is a step-in clause which allows the funder to take control of the relevant contract following an event of default by the ‘employer. The funder will usually have the power to arrange for a new body/project, Company to take over the administration of the project from the employer. ‘The direct agreement will usually require the ther parties to the relevant contract (such as the contractor in the case of the building contract) to forego or suspend any rights they might have to terminate the contract whe the funder finds a substitute project company. The clause wil usually require the funder to find a body with the same level of experience and financial resources as the original employer. Figure 13 ilustrates the structure where direct agreements are entered into relating to property development transaction. ‘CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 23,Figure 13- Structure ofa direct agreement relating toa property development transaction 2.7 Payment security methods 2.7.1 Escrow account A typical building contract requires regular payments by the employer to the contractor as ‘work progresses. An escrow account may be used as a safeguard for all payments or it may be put in place as a safeguard to be called upon only if the employer fails to make one of the payments owing under the building contract 2.7.2 General provisions ‘An escrow account is usually documented by the following: ‘© acontract that formalises the escrow arrangements @ alletter instructing the bank or other escrow ‘agent how to operate the account; and/or ‘© an amendment to the building contract to adjust the payment provisions to take ‘account of the escrow arrangements. The contracts should clearly set out what sums are to be paid into the escrow account and Ewa ! Ca ) Building Comer 4 ers ener when and how the funds are to be distributed from the account. There may be provisions under which the monies in an escrow account are held on trust for the contractor in order to ring-fence such monies in the event of employer insolvency. 2.7.3 Project bank account A project bank account is intended to speed up payment in a construction project, reducing the risk of cash flow problems in the supply chain. This is because, depending on the terms of the relevant agreements, a payment from the employer to the contractor does not have to flow down from the contractor to their sub- contractors - they are all paid at the appropriate time through the project bank account. In essence, the employer and. generally the main contractor jointly open the project bank account and money is paid into it by the employer in accordance with the contractor's contractual entitlements. The ‘monies in the account are usually held in trust by the employer and the contractor for the benefit of the contractor and their supply chain, Therefore, the supply chain should have access 24 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS.to the monies if the contractor becomes insolvent. Project bank accounts are more likely to be seen in public sector projects but are increasingly being used on major projects. 2.7.4 General provisions There will normally be a provision in the building contract setting out the project bank account provisions. There may then be a separate agreement dealing with the project bank account itself. The key provision is an Undertaking from the employer to pay monies ‘due under the building contract into the project bank account as and when they become due. The contractor will identify sub-contractors that will be paid directly from the account. There may be provisions stating that the monies paid into the account are kept separate and distinct and clearly identifiable, and that they will be held on trust for the contractor and other relevant parties until they are ultimately paid. ‘As with the escrow account provisions referred to previously, the intention is to create a trust, ring-fencing the funds in the account for the benefit of the parties to be paid in connection with the project. CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS | 25,3 Practical considerations (Level 3 - Doing/Advising) 3.1 Introduction This section looks at practical considerations which a chartered surveyor should take into account when reviewing construction security and performance documents in a construction project. It is important to note, however, that this guidance note is @ brief introduction and should not be relied on as a substitute for appropriate professional advice. 3.2 Parent company guarantees — items for consideration 3.2.4 The form of parent company guarantee is usually prepared by the employer, although major contractors often have their own forms of guarantee that they prefer to use to guarantee the performance of a subsidiary on a particular project. The law relating to guarantees is complex; specialist advice should be sought, where appropriate. Background information on the general principles of law in this area is provided at paragraph 1.4.2. 3.2.2 The parties should carefully consider the reasons for a parent company guarantee and (if appropriate) any additional or alternative security that the contractor or the employer may be able to provide, e.g. in the case of a building contract, if a performance bond is being provided, is it necessary to provide a arent company guarantee as well? This will depend on the particular project: often, in complex projects, both will be required. Performance bonds and parent company guarantees provide different remedies, types and levels of protection to the employer for contractor default. Bonds (among other things) provide access to a pot of money to cover the cost of appointing a substitute contractor if the original contractor becomes insolvent; parent company guarantees attempt to ensure that the parent will ‘see to it’ that their subsidiary performs in a potential default situation. Clearty, if the contractor does not have a parent company (or other appropriate company within the group) a parent company guarantee cannot be given and other security (such as a bond) may be sought. 3.2.8 Consideration should be given to which body is providing the parent company guarantee. Is it the ultimate holding company in the group or an intermediate company? Where exactly does the company giving the guarantee sit within the company's overall group structure? Financial checks on the body providing the guarantee will be required. The aim should be to obtain a guarantee from a company within the group which owns significant assets. For example, in the case of an employer, it is common in many development projects for developers to set up special purpose vehicles (SPVs) which have very few assets. The important point is to undertake financial checks; such checks may show that the parent company or even the ultimate holding company have fewer assets than the contracting party themselves, which would therefore mean that any parent company guarantee given by these companies will be of little additional value. However, it may be difficult, in practice, to ascertain where control and ownership of the group assets really lie. A parent company guarantee will, of course, be of little or no benefit if the parent is ultimately equally unable to perform the contract (e.g. if there is a group insolvency). This is likely to be a factor to consider in choosing whether to have a performance bond in place of, or as well as, a parent company guarantee. 8.2.4 Where is the company giving the guarantee resident? Is it a company registered 26 | CONSTRUCTION SECURITY AND PERFORMANCE DOCUMENTS.