What is bank guarantees and its types in construction industry?

“Bank Guarantee is an assurance to a beneficiary that the bank will uphold a contract if the applicant and counterparty to the contract are unable to do so”

A bank guarantee is an obligation from a bank (the guarantor) to pay a certain amount to a guarantee creditor if our customer (the guarantee debtor) does not meet their obligations in an agreement. 

1	Tender bond:

Imagine you wanted to build a building, so you call all the contractors to quote their price for this project

Now You setup a tender committee from your office who will verify these contractors and help you in selection process

Now Each contractor has to submit the tender documents to participate ie quotation/certificates requested /BOQ etc

Lets suppose if Michael is quoting for  5M,John is quoting 3.5M,mark quotes for  4M. and so on Each contractor starts quoting

Now Tender committee spends days together to verify these tender documents and for selection process. Now lets assume John is selected to build this structure

Deal is done! You are excited What Next.. While you are expecting to start the execution process and contract signature

John backs off and  wants to withdraw his offer

Now Your whole time and money  spent and tender committee salary you paid went for a toss

Here comes the need for Bid bond/Tender bond

So you request the contractor to give the Bid bond guarantee from bank, where bank wil pay the money on failure from the side of the contractor, so this guarantee paper will be converted into cash upon liquidation claim

So this becomes a practice in the construction industry that whenever you wanted to participate in tender,you have to submit bid bond along with other tender documents…to include this guarantee in tender participation documents. So,Next time you wanted to participate in any  tender, ensure if bid bond is one of the requirement

2	Advance Payment Guarantee

Lets assume the Project is awarded to John

Now he has come up with the request for 10% as advance money to manage his cash flow

as he has to bring in materials of big value and more labors and equipment's etc

So he needs advance money of 10%

 I am worried. But what if pay John the 10%  money and but doesn’t start the work and nor he wants to return the money

So in order to secure the advance payment money I ask for advance payment guarantee

This guarantee will activate only upon receiving of the advance money in the account

I can liquidate this guarantee if the contractor fails to fulfill his obligation

3	Performance Bond

Lets use the same scenario...Imagine John has signed the contract

Now your project is half completed and you are in midway

for sone reasons...John backs off. May be due financial reasons. He doesn’t want to continue

Example 2:Lets say John has completed the work..but. The work is not fully satisfactory OR quality is not up to mark

Now are concerned about the project timeline you promised to others

If you want to appoint the new contractor, he might charge you double as it is in the midway and duration is also less

So here comes the Performance Bond

Therefore you secure the project with bond value from the bank

4	Retention Bond

In most cases, client holds 5% or 10% as retention money.

Imagine John completed the work as stated in the contract. So he hands over the project stating 100% job completed. So you settle all the money as per the contract

Now After 3 months you notice some defects..

So you request contractor to rectify the defects post contract. There might be a chance wherein contractor refuses to rectify

Here comes the for retention bond

in some cases, retention bond is replaced with the money to free up the cash flow