Performance bonds are a common part of many infrastructure projects. As local authorities are increasingly finding themselves having to arrange these bonds, Tom Holmes, Public Sector Client Management Director at Aon, explains the options.
The government has earmarked £650 billion for national infrastructure and construction over the 10 years to 2030/31. But, while this investment is welcome in our growing towns and cities, local authorities could find themselves having to take out performance bonds to guarantee their obligations under the Highways Act.
Section agreements
Under the Highways Act 1980, developers, and in some cases other stakeholders, are party to a section agreement. The agreement outlines the obligations of all parties when work is to be undertaken to public infrastructure, mainly roads, water, and sewer mains.
Common section agreements include:
- Section 38 (s38) – the developer proposes to construct a new road for residential, industrial or general purpose traffic
- Section 278 (s278) – the developer proposes permanent alterations or improvements to existing highway infrastructure
- Section 104 (s104) – the developer is attaching new drainage / sewerage infrastructure to the existing network
As well as providing terms and conditions around the work and the standards expected, these section agreements also set out security arrangements, with performance bonds typically required. If the developer goes out of business during the works or it fails to hand over the site in a suitable state for adoption by the county council, it has a right to make an on demand call on the bond to fund corrective work.
Shifting responsibilities
While performance bonds have historically been a regular feature for contractors and developers, over the last year Aon have seen more local and district councils having to put the performance bond in place. This is particularly the case for s278s.
There are a few different ways in which local authorities can put the necessary security in place. Banks can offer this facility by ringfencing cash for the duration of the bond, or by offsetting the bond amount against existing credit lines.
Insurance market offering
An alternative solution is a surety bond issued via the insurance market. This external and unsecured credit line offers competitive rates, and frees up working capital to be utilised elsewhere, as an uncommitted facility. There is no charge for facilities that are not drawn down.
The bond amount is typically the cost of the works but it is also possible to tailor a bond to the specifics of the section agreements. As an example, a county council may require the bond amount to reflect its exposure during the construction project if it does need to rectify the works. This could reduce during the contract as phases are completed and signed off.
The length of a bond can vary too. Many will last for several years, reflecting the duration of the project up to the point when the county council adopts the road or other infrastructure.
Premiums are based on the bond value and rates on the financial stability of the local authority.
Managing risk
As well as factoring in any additional costs associated with arranging a performance bond, the shift to local authorities placing bonds means a robust due diligence process is essential.
Where the local authority carries some of the financial liability for the works, it is important to have the necessary checks in place to ensure that any contractors have the skills, experience and financial security to deliver the construction project on time and to the agreed standards.
More information
To find out more about any issues relating to section agreements and performance bonds, speak to your Aon account manager or contact Tom Holmes at [email protected].
For more detailed information about performance bonds and the options that may be available to your authority, contact James Ellison, specialist bond and guarantee broker at Aon, at [email protected].
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