Whenever people think of performance security under a construction contract, cash retentions and bank guarantees are the first things that come to mind. Yet they are not the only options present. Why? Because an expert witness Dubai has decided to share with us the various kinds of security present under a construction contract:
Cash retentions
This is perhaps the most common kind of security, especially for smaller contracts. It usually involves cash retention.
Here, a small amount of cash is withheld from the contractor’s claim. It is usually around 10 percent of the claim. However, if a certain value of the security has been accumulated (5 percent) then the sum may rise.
One of the main benefits of such an arrangement is that it is simple. However, there is a downside for the contractor. That is, it can affect the contractor’s cash flow negatively.
Head contractors also need to remember the recent decision made in Maxcon. Here, it was determined that a retention agreement will not be effective where the obligation to release the security depends on the working and operation of another contract (like the head contract).
A separate bank account
This serves as an alternative to cash retention; sometimes the security amount will be paid into a separate bank account. This account will be potentially controlled by both involved parties, or it will be a trust account of a solicitor.
The purpose of such an arrangement is to give the contractor greater comfort. Eventually, they will receive the security amount once the obligations have been discharged. Like cash retention, the main disadvantage of a separate bank account for the contractor is the impact of this arrangement on the cash flow.
A lot of states in the United States and Australia have begun mandating project bank accounts as part of the security of payment legislation. This is true for Government projects or projects which are above a particular size.
As a matter of fact, the Australian state of Queensland contemplates a specific bank account being set up to hold retention. This is done on the basis set out in the aforementioned points.
Bank guarantees
A bank guarantee is an undertaking given by a bank. This is done so parties in construction can take security from contractors (usually in the form of cash) to ensure they are protected if the bank guarantee is needed.
Many contractors prefer bank guarantees to cash security. The main reason for this is to avoid the negative impact on cash flow associated with cash retentions.
Insurance bonds (surety bonds)
Insurance bonds are similar to bank guarantees, in a way they are issued by a third-party financial institution (often by an insurance company. They are payable on demand to the named beneficiary.
The difference between a bank guarantee and an insurance bond is that issuers of the latter often do not require the bond to be secured by a cash deposit. The outcome is that insurance bonds are often better for the contractor’s cash flow.
The con however is that the upfront costs associated with an insurance bond are usually higher than those associated with a bank guarantee.
Letter of comfort
This letter is basically an assurance given by a third party. It could be a bank, an accountant, or a relevant corporate body. This is about the financial standing and situation of a particular entity. A letter of comfort cannot be retreated as security, in any sense.
The value of a letter of comfort depends on what is said. For instance, if the letter is not properly representing the contractor’s financial position, if it makes representations about future matters without a reasonable basis for such, then it could find itself liable for a breach of misleading and deceptive conduct provisions present in the Australian Consumer Law.
A letter of comfort is often regarded as an inferior type of security.
Mortgage over land
This occurrence is unusual. A quantum expert in Dubai explains that a mortgage over land can be used as a security under a construction contract. This is done in the same way a bank takes a mortgage over land in securing a loan.
In such a context, mortgages are rare due to the following factors:
- The parties will normally be able to agree on a different regime without having to go for a mortgage.
- Contractors are often not usually inclined to give such kind of security.
