Performance and Payment Guarantee Issues

A project developer may want its contractors to ensure, for the project developer’s benefit, (1) procurement of performance and payment guarantees or bonds to ensure timely performance of contractors under the relevant agreements and (2) that no liens or undesired security interests are lodged against the project in relation to unpaid subcontractors.  These guarantees and bonds are described below.

Performance Guarantee or Bond 

A performance guarantee or bond is usually issued by a parent company or another creditworthy entity, such as a bonding company, selected or approved by the project developer.  Under the guarantee or bond, an agreed-on sum is available to satisfy the project developer’s damages arising out of the contractor’s failure to perform as specified in the relevant agreement.  The bonding company charges a fee and retains the right to seek reimbursement from the contractor or contractor’s guarantor.  If the contractor defaults or cannot complete the project, the project developer may call on the guarantor or bonding company to perform the contractor’s obligation (for example, by paying another contractor to complete the project).  The project developer will want to reserve all rights against the defaulting contractor if the performance guarantee or bond does not fully cover the project developer’s costs of completing the project or costs associated with any damages for which the project developer has to pay to a third party.

Payment Guarantee or Bond

A payment guarantee or bond provides assurance that upon the contractor’s default, employees and subcontractors will be paid for work performed so no liens or other security interests will attach to the project developer’s property or to the project.  A lien claim, normally filed against the project developer’s property, may be bonded over so the lien attaches to the bond rather than to the property.  Lenders, upon their review of the agreements, may demand or require such payment guarantees or bonds to enhance the lenders’ security interests in the project, particularly if the commencement of work (which may give rise to lien rights) predates the lenders’ recorded interests in the property.

The project developer or the lenders may require other security from contractors such as standby letters of credit and insurance listing the developer and lenders as additional insureds.  The contractors will demand ample opportunity to cure any default or delay and will seek to limit the project developer’s ability to call on performance or payment bonds or other security that may be given.  Further, contractors will usually demand some form of reciprocal security issued by the project developer or its parent company, such as a parent guarantee, particularly if the project developer’s only substantial asset is the project itself.

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