Seven years on, the standard conditional bond product continues to fall short of this ideal and remains difficult to call. Typically, it requires proof of default as well as a final ascertainment of the amount of loss before a claim can be made. Moreover, there is a long history of claimants having to litigate and suffering delay in enforcing these bonds.
As a result, clients have experimented with other means of performance security – for example, through increased retentions or escrow accounts, neither of which is particularly popular with the contracting community. Even less popular (except on international limited recourse financed projects) is the requirement for on-demand bonds as security for performance. These bonds are no longer readily available in the UK, partly because of concerns over wrongful calls, but also because of their relatively high costs and their balance sheet treatment, which would otherwise constrain the number of projects that even the largest UK contractors could handle. Indeed, the DOE guidance has labelled on-demand bonds as "anti-competitive".
However, over the past few years, a possible solution has emerged in the PFI market, in the shape of the adjudication bond. In the early PFI deals, they followed an on-demand format but were subject to a condition that any demand would have to be accompanied by a certificate of entitlement from an individual who was then called an "expert", but which we would now recognise as an adjudicator.
More recently, the PFI market has developed a more sophisticated adjudication bond in a conditional bond format. In these adjudication bonds, the risk of lengthy delay on claims under conditional bonds is reduced by expressly requiring the surety to pay where liability is established under adjudication proceedings.
The adjudication takes place under the underlying construction contract, unless the contractor is insolvent, in which case the bond should contain a stand-alone adjudication procedure. This is partly because the surety will wish to have greater control over the adjudication proceedings if the contractor is insolvent, but also to cover those cases where the law shields the insolvent contractor from adjudication and other dispute proceedings. The bond will also typically contain a reconciliation mechanism in case it is subsequently determined that the surety either made an under- or overpayment based on the adjudication award.
Adjudication bonds on PFI projects are often combined with an "acceleration" of the contractor's termination liabilities under the construction contract to provide forward-funding of the anticipated costs of completion of the projects. This is intended to have a similar effect to the forgotten ABI financing bond.
There is no apparent reason why adjudication bonds should be restricted to the PFI market. Indeed, their features suggest the same format could be of equal benefit on other projects where performance security is required and clients are dissatisfied with the cover provided by traditional conditional bonds. But two words of warning: n First, adjudication bonds have tended to be heavily negotiated on PFI projects, resulting in bespoke documents. It is only recently that a relatively standardised format has begun to develop. You can expect sureties to take a much greater interest in the underlying construction contract risks than they might with traditional conditional bonds. Increased risks and due diligence are likely to be reflected in the premiums.
Postscript
David Metzger is a partner in the Construction Group at Clifford Chance.
