In construction contracts, financial security is essential for protecting employers against contractor default and insolvency. Understanding the available security options helps employers make informed decisions that safeguard their projects and investments.
There are a variety of means available to an employer when it comes to financial security under a construction contract. An employer may seek the following from a contractor:
- Parent Company Guarantee (˜PCG);
- Performance Bond; and/or
- Bank Guarantee.
This article considers, in brief, each of the above forms of security.
Understanding Parent Company Guarantees (PCG)
To be able to obtain a PCG a Contractor must be part of a group of companies and have a parent company that is willing to provide the guarantee. Even then, for said PCG to be worth the paper it is written on, the parent company must have sufficient assets.
An employer will want the terms of a PCG to guarantee all liabilities of the subsidiary company under the building contract. A PCG will be for the duration of the contract works plus 12 years following practical completion if the contract has been executed as a deed, or plus 6 years if contract execution has taken place underhand.
Whilst, in theory, a PCG may offer the best form of security, it will only be as strong as the solvency of the parent company. If the parent company does not have sufficient assets to enforce the terms of the guarantee against, or if it were to become insolvent, then a PCG will have little to no value. Employers may therefore require further security, for an additional safety net.
How Performance Bonds protect construction employers
Performance bonds provide financial security to an employer for the contractors obligations and/or the risks associated with advance payments. If the contractor fails to deliver the works to the value of the advance payment or becomes insolvent, then an employer can make a claim against the bond to, for example, recover the advance payments made. An employer will want to ensure that the bond can be called upon on demand without needing to evidence the contractors default. The latter would attract protracted arguments surrounding whether a default has occurred to trigger the bond. As such, payment on default bond terms should not be used.
A performance bond providing security for the contractors obligations will tend to be for the duration of the contract works, plus the defects liability period. Whereas a bond providing security for advance payments will be until such time as the advance payments have been set off under the contracts interim payment cycles.
Performance bonds are issued by an independent surety (i.e. a bank or insurer) and will typically cover 10% of the contract value, though can be much higher. They are a type of insurance. As with any insurance policy, its terms will limit the ability to make a claim.
Performance bonds can be expensive and provide only a limited amount of protection to an employer, though may be utilised if no other security is available.
Bank Guarantees for construction contracts
Bank guarantees are (as their name suggests) issued by banks and will provide an employer with financial security for the contractors obligations under the building contract. Pursuant to the terms of an on demand form of guarantee, the issuing bank would be obliged to pay a specified sum to the guarantees beneficiary on demand, without requiring proof that the contractor has defaulted on its contractual obligations. In contrast, the terms may be such that payment under the guarantee would be subject to proof of contractor default. However, it is worth noting that, almost invariably, the terms of a guarantee will be on demand as a bank will not want to be involved in drawn-out arguments concerning whether default has occurred.
The guarantee may be structured to cover a percentage of the contract sum and remain valid until a specified period following practical completion of the works.
Whilst bank guarantees can provide a reliable form of financial security, a bank will only be willing to offer a guarantee if it has, under its control, the monies equal to or greater than the amount of the guarantee being sought. Subsequently, this may prove somewhat of a non-starter. If an employer is exploring forms of security on the basis that they are concerned with the financial health of a contractor given the information available on Companies House, it may follow that there is not sufficient cash in its accounts under the banks control.
Considering financial security for construction projects
With contractor insolvency on the rise and accounting for 17% of all insolvencies in England and Wales in the 12 months to October 2025, Employers really ought to be giving consideration to obtaining some form of financial security.
The best form of security will be dependent on the nature of the project and what is available. Whilst a PCG may be considered the most desirable form of security, it may not always be obtainable. Equally, performance bonds and bank guarantees are likely to prove expensive, and the cost associated with obtaining these will be reflected in an increase to the contract sum.
What is certain is that the terms of any bond/guarantee require careful drafting to ensure that an Employer will be able to promptly access funds if the contractor were to default on its contractual obligations. Legal advice should always be sought in this regard.
For any questions relating to this article or for advice contact our Construction Solicitors.
