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The various kinds of security present under a construction contract

construction-security

When people think of security present under a construction contract, the first thing that comes to mind is bank guarantees and cash retentions. They come to mind because they help bring cash when the situation goes down.

Somehow there are other options present. We will now explore those options in brief detail:

#1 Cash Retentions are present

The most common kind of security present. Cash retentions work for multiple kinds of contracts (especially smaller ones). They usually involve cash retention. They often withhold a small amount of money from the contractor’s claim i.e. almost 10 percent. This is done until and unless a certain security value has been accumulated (like 5 percent of the contract sum).

The main benefit of this arrangement is that it is easy to execute. Yet there is a downside in it mainly for the contractor.  It affects their cash flow negatively.

Chief contractors should remember that a retention agreement won’t be effective where obligations to release security depend on the function and operation of another contract.

#2 A different bank account

A different bank account is an alternative to cash retention. Sometimes, the security amount present will be paid in a different or alternate bank account. Both parties involved in the project will potentially control it. Mostly, such accounts’ control is provided to solicitors of trust accounts.

The purpose of this arrangement is to help provide contractors with a wide degree of relief. Contractors will eventually receive the security amount once all obligations have been fulfilled. A major problem with a different bank account for a contractor is that it harms cash flow.

In Australia and the United States, many states and municipalities have started mandating project bank accounts as part of legislation regarding the security of payments. It works in government projects and for those which are in the large size category. The state of Queensland in Australia plans specific bank accounts set up to help in holding retention.

#3 A bank guarantee is also present under a construction contract

A bank guarantee is an undertaking given by banks. It helps parties involved in construction projects to take security from contractors in the form of cash. It helps them get protection if a bank guarantee is required.

Contractors prefer them over cash security. One of the main reasons is that it helps them avert the negative impact on cash flows associated with cash retention. Quantum expert professionals have observed this trend.

#4 Insurance bonds

Insurance bonds are similar to bank guarantees. These bonds resemble those guarantees in the manner that they are used by a third-party financial company like an insurance company. They are payable on demand to the named and intended beneficiary.

It is not the same as a bank guarantee. The difference is that issuers of insurance bonds usually do not require the bond to be secured through a cash deposit. The outcome is that insurance bonds are usually a better option for the contractor’s cash flow.

However, a disadvantage is that upfront expenses associated with insurance bonds are higher than those associated with bank guarantees.

#5 Mortgage preferred over land

Preference for mortgage over land is unusual. Even construction claims professionals find it unusual. They determined that a mortgage over land can be used as collateral and security under a construction contract. The process resembles a bank taking a mortgage in place of land to secure a loan. Such a phenomenon is rare due to the following factors:

  • Parties will usually be able to agree on a different modus operandi without the need for a mortgage.
  • Contractors aren’t inclined to provide such kind of security. 

#6 Comfort letter (letter of assurance)

A comfort letter is a sort of letter of assurance. Third parties give it which can be an accountant, a bank, or a relevant corporate body. This is about the financial situation of any party involved in construction and this letter cannot be treated as security.

Instead, its value depends on what is being said in it. For instance, if the letter does not properly represent future matters without any proper basis then the letter issuer and guarantor will find themselves liable for breach of contract, deceptive and misleading practices, and deceptive provisions.

Conclusion

The kinds of security present under a construction contract range from recommended to informal ones. The ones that are recommended are insurance bonds, cash retentions, and bank guarantees.

Contractors often find themselves at odds in most projects due to a lack of proper security in financial terms. They often end up paying for more expenses than anticipated and this in turn leaves them in a precarious financial position. A lot of contractors often go out of business prompting them to leave any hopes of returning to the industry.

This causes ripples in the industry and an upward spike in construction claims. When they file claims, construction companies face unintended consequences.

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