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Construction Guarantee Wordings in the Insurance Market – An Underwriters Perspective

Published

2015

Fri

16

Oct

 

Clive Sparks, head of the Infiniti Guarantees division of Infiniti Insurance says, “It is imperative that one understands why the contractor provides the employer with a guarantee, and to understand the fundamental purpose of the guarantee.”

He goes on to say that, “The guarantee is an agreement between the employer and the contractor. It provides a level of comfort to the employer, and protects the employer against any losses incurred should the contractor fail to perform in terms of their contractual obligations, or should it become necessary to engage an alternate contractor.

Traditionally contractors obtained their guarantees from banking institutions, but due to the high collateral requirements, sometimes as high as 100% of the value of the guarantee, this meant that valuable capital was tied up by the contractor, which could otherwise have been used to fund working capital requirements such as taking up site and purchasing equipment or materials for the contract.

In latter days, we started to see insurers offering guarantee facilities to contractors, as these insurers were willing to share in the risk. This often leads to far reduced collateral requirements for contractors. Insurers embraced and supported specialist construction guarantee underwriters who understood the nature of guarantees, the related terminology, legal agreements and who were able to understand the credit risk of the contractor as well. Such insurers are thus able to provide expert advice and tailor-made products suited to the contractor. This became a game changer.

We now see two versions of guarantee wordings, namely the ‘Unconditional demand wordings’ and the ‘Conditional demand wordings’”.

Paul Hancock GM of Infiniti Specialist Underwriting division counters, “Previously, when a contractor approached his bank for a guarantee, and because the bank took little or no risk by holding such high collateral security, the bank could accept and issue the guarantee on an unconditional demand guarantee wordings which certainly was not equitable to the contractor.

The dangers of an unconditional demand guarantee wordings is that it provides no rights to either the contractor, or the insurer, who has agreed to share a portion of the risk. For this reason, it is frowned upon by Reinsurers, due to the absence of an event or trigger mechanism. Such a guarantee wordings would allow the guarantee to be called up and payment demanded irrespective of the reason that caused the contractor to default, with no proof of breach needing to be proved?”

This situation has led to insurers and reinsurers alike, preferring the Conditional demand wordings, which provide rights not only to the employer but the contractor as well. This wording is perceived to be fair and equitable to all parties. For the employer to make a call on the guarantee, the employer will have to notify the contractor in writing of the areas where they are not performing, and to give the contractor an opportunity to rectify any delays or default within an agreed period of time. Should the contractor fail to comply at the end of this period, then a call can be made on the guarantee by the employer for payment by the guarantor. However, the employer must provide proof of the default with copies of supporting documentation and notices served on the contractor, as well as the determined value of the loss incurred by the employer as a result of the failure of the contractor to perform their contractual obligations.

Sparks indicated that, “From the onset, neither the employer nor the contractor should focus on the guarantee, but rather to working together to ensure the successful completion of the project.

The employer ultimately dictates which guarantee wordings to use, however, in many instances this is dependent on the type of contract entered into between the employer and the contractor.

Various types of contracts such as the Joint Building Contracts Committee (JBCC) have their own set wordings, and they are generally acceptable to all insurers in the market, as these are the most commonly used wordings today.

The problem that most insurers are faced with today is that over the years many standard guarantee wordings have been amended by large corporate employers, which in many instances has rendered these wordings unconditional and thus less attractive to insurers. It is of vital importance that the insurer consider the contract wording carefully before making a decision whether to accept or decline the risk.”

 
Source: Infiniti Insurance Limited
 
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Bond, Fidelity:

A bond that indemnifies an employer from a loss or losses sustained through dishonest acts of bonded employees. Also known as fidelity guarantee.
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