Most major construction works are governed by standard form construction contracts which require both the employer and contractor to provide each other with guarantees. For readers not familiar with engineering and construction contract parlance, an employer is the owner of the asset being constructed and the contractor carries out the construction of the asset. Guarantees are legal agreements used to protect the employer against the contractor’s failure to carry out its duties under the construction contract and vice-versa. This post briefly discusses the three guarantees given in favour of an employer or contractor under the Joint Building Contracts Committee’s (“JBCC”) Principal Building Agreement (“PBA”), a standard form construction contract widely used in Southern Africa. It is important to note that there are several other standard form contracts such as FIDIC and NEC contracts used internationally and other jurisdiction specific contracts that have different guarantee regimes to JBCC contracts.

It will likely happen that after signing the construction contract either one of the employer or contractor will fail to perform in terms of the construction contract between the two. Non-performance will result in undesired delays and cost overruns. An aggrieved party to the construction contract can in such situation rely on common law remedies for non-performance such as demand for specific performance, cancellation and damages. However, these remedies are not always readily available, can be uncertain or be insufficient to compensate for losses suffered. Additionally, the court process under which these remedies are granted can take long, resulting in loss of value in the final remedy vis-a-vis the costs incurred. Guarantees provided on signature of the construction contract then step in as the readily available, certain and sufficient remedy for non-performance. Albeit guarantees do not exclude a party’s right to rely on common law remedies.

When an employer and contractor agree for the construction works to be governed under the JBCC’s PBA there are three types of guarantees which they can give to one another. These guarantees are (i) a Construction Guarantee, (ii) an Advance Payment Guarantee and (iii) a Payment Guarantee. It is important to note that although guarantees are required under the PBA and other standard form contracts they are stand-alone agreements made separately from the construction contract. They constitute a promise made by an approved financial institution, referred to as a guarantor, to pay a sum of money to the employer/contractor in the event of a default by the contractor/employer. The guarantor, who is usually a short-term insurer, must make the payment to the employer/contractor on demand and in accordance with the terms set out in the guarantee only. The terms and conditions of the construction contract are excluded unless expressly stated in the guarantee.

Construction Guarantee

The Construction Guarantee indemnifies the employer against the contractors default under the PBA and is procured by the contractor in favour of the employer either on a fixed or variable basis. A Fixed Construction Guarantee provides cover to the employer for a sum not exceeding 5% of the contract sum, which remains valid from date of issuance until the last practical completion certificate is issued by the Principal Agent. 

On the other hand, a Variable Construction Guarantee provides the employer with a maximum cover of 10% of the total amount to be paid for the construction works (“contract sum”). This cover is valid from the date of its issuance until the interim payment certificate adding to an excess of 50% of the contract sum, is issued by the Principal Agent. Cover to the employer is then reduced to 6% of which it is valid only until the last certificate of practical completion and then from there it is reduced to 4% until the last certificate of final completion. The last reduction on cover is done at 2% from the last certificate of final completion until the final payment certificate when the whole guarantee expires.

The employer is entitled to demand payment of the Construction Guarantee, fixed or variable, from the Guarantor in three instances. Firstly, for the payment of a sum certified by the Principal Agent. Secondly where the PBA has been terminated due to the contractors breach and lastly where a competent court has granted a provisional sequestration or liquidation order against the contractor.

Advance Payment Guarantee

This guarantee is made available to the employer, if it has made a payment in advance to the contractor for materials and goods for the construction works, of which it has not gained full ownership of such materials or goods, or it has not yet recouped the amount of the advance payment. The Advance Payment Guarantee provides the employer with cover for the balance of the amount for the materials and goods bought and utilised in its favour against the amount it paid to the contractor. The guarantee remains valid from the date it is issued until the employer recoups its amount as set out in the milestones provided in the guarantee. If the contractor fails to attain particular milestones the employer is entitled to demand payment of the outstanding balance from the Guarantor.

Payment Guarantee

Unlike the Construction and Advance Payment Guarantees, the Payment Guarantee is procured by the employer in favour of the contractor. It indemnifies the contractor if employer fails to make payment to the contractor and if the employer requires the contractor to waive its lien over the construction works. The Payment Guarantee is valid as from the date of its issue until issuance of the Final Payment Certificate by the Principal Agent, or upon payment in full of the Guaranteed Sum stipulated in the Payment Guarantee or on the Guarantee Expiry Date provided in the Payment Guarantee.

The contractor may demand that the Guarantor pays the guarantee in two instances. Firstly, the contractor may issue the guarantor with written demand for payment of a sum certified by the Principal Agent. Secondly, it may issue the guarantor with written demand for payment of a sum state in a payment certificate.

Conclusion

The JBCC’s PBA provides for three standard guarantees against performance between an employer and contractor, of which two are issued in favour of the employer. By virtue of all three guarantees being available on demand they give incentive to the employer/guarantor to perform as agreed between the two. Payment can be demanded within as little as 14 days from the date of breach of the construction contract. The Construction Guarantee which provides the employer with cover over the construction works will however, likely take longer than other guarantees. This is because if it were to be invoked in cases where termination of the construction contract or sequestration/liquidation of the contractor have occurred the demand for payment may be made to the Guarantor long after the initial damage has been suffered by the employer. Although, they must be paid on demand to the Guarantor, these guarantees remain conditional and require certain events to occur prior to either the employer or contractor demanding payment.