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Common Types of Guarantees

Bid Bond - It is used when tenders or contracts are floated by project owner companies to gather applications of willing contractor companies to bag the contract to deliver the project. This type of guarantee ensures that the company bidding or applying for the tender has all the legitimate papers and has the capacity enough to sign the contract in case it is awarded the contract. Also, it ensures that the bidding company has enough financial standing to submit a performance guarantee that may be required to cover the risk once the project commences.

Performance Guarantee - This type of guarantee covers the risk of any kind of non performance by the contractor. If there is any issue with the project delivery by the contractor who is allotted the contract, for example, delay in work or quality issues, the project owner company will lodge a claim under the performance guarantee by submitting the documents called for in the guarantee and get itself compensated. If all goes well, the guarantee will be kept as a standby instrument, meaning, ‘required just in case any default arises’ and will be cancelled subsequently once its expiry gets over.

Advance Payment Guarantee - Most big international projects involve some portion of the project cost to be paid upfront to the contractor by the project owner company so that the contractor can make necessary arrangements to begin the project work. But what assurance is there that the contractor will not abscond with the advance payment once received without completing the project? For that, the advance payment guarantee is used. If by any chance the contractor receives the advance payment and then leaves the project, then the project owner company will invoke a claim under the advance payment guarantee to the guarantor bank and get back the advance amount.

Retention Money Guarantee and Warranty Guarantee - As the work of the project continues, payment is made stage by stage to the contractor by the project owner company. Sometimes, after the completion of the project, the last tranche of payment, supposedly 10% of the project cost, is retained by the project owner company unless it is fully satisfied by the quality of the work done by the contractor company. This is called retention money. But this may cause a cash crunch for the contractor company. To avoid that the contractor may provide the project owner company a retention money guarantee and in return get paid for full 100% of the project value. In case the project owner finds that the work done by the contractor is not as per the contract, it can invoke claim under the guarantee and get back the retention money as compensation.

Warranty guarantee is very similar in purpose to retention money guarantee. It covers the risk of quality or performance failure after a project is completed but within the warranty period.

Payment Guarantee - To safeguard the payment to the contractor, there can be a payment guarantee in favour of of the contractor where the project owner company will be the applicant to the guarantor bank. It is to ensure that the contractor keeps on getting regular batches of payment according to the payment schedule as and when payment becomes due. If there is any default of payment by the project owner, then the contractor can invoke the guarantee to the guarantor bank and get compensated. The value of the guarantee can also reduce gradually if there are multiple payments involved.

Chronology of Guarantees in a contract

The chronology - Horizontal Line is the timeline of the project work

So, in the case of an international job contract, the chronology of the guarantees needed may be like this - 

At the very beginning, during the duration of the tender, a bid bond is required to be submitted by the contractor. 

Then on successful signing of the contract, for the project owner or the buyer, a performance guarantee is required. Also, if advance payment is involved, then the contractor also submits an advance payment guarantee. The value of the advance payment guarantee may be reduced over time as each stage of the contract is completed. 

The performance guarantee amount is the amount which comes after deducting the advance amount from the full contract amount. The performance guarantee remains in force till the project continues. 

On the other side, the project owner may need to arrange for a payment guarantee from a bank to safeguard the regular payments to be made to the contractor. 

At the end of the contract period, if there is retention money involved then the contractor can submit a retention money guarantee to release the last phase of payment. In place of the retention money guarantee, a warranty guarantee can also be submitted.

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