Performance security part two: Parent company guarantees

This is the second in our series on performance security in the construction industry – an important consideration for clients and contractors before commencing a project. We are considering recent trends and what these mean in practice.

Part 1 considered performance bonds; here we’ll focus on parent company guarantees (PCGs).

A PCG is a guarantee given by a parent company to the client, typically to secure the performance of its subsidiary's contractual obligations and guarantee that the parent company will fulfil the subsidiary's obligations if they default. They are commonly drafted (by clients) on an indemnity basis.  

Whilst PCGs are often considered the easiest of the performance security options to obtain and are often offered as an alternative to a bond, they come with a health warning. There is a real risk that if the contractor ceases trading, the parent company may cease trading too. This is obviously not a consideration when obtaining a bond.

Key points include:

• Identity and financial covenant of the guarantor – it should be confirmed that the guarantor is truly the ultimate parent company with the appropriate financial covenant and not merely another group company.
• Trigger for payment – there needs to be a trigger point, typically this would include breach of contract by the contractor and insolvency.
• Amount – the guarantor has like-for-like liability with the contractor under the building contract.
• Expiry – a guarantor’s period of liability will mirror the liability period in the underlying contract – so a PCG will almost certainly be in place for longer than a bond.
• Equivalent rights of defence – it is usual to have an equivalent rights of defence provision and for the guarantor to have the benefit of any caps on liability or other limitations in the underlying building contract.  
• Cost – they do not commonly have an associated cost and are usually straightforward to obtain if the parent company’s own template is used.

Payment guarantee

Single purpose vehicles (SPVs) are commonly used to develop out sites. Such SPVs are often companies with a £1 share capital, albeit that they are backed by cash-rich entities.   Payment guarantees are often overlooked or there can be a perception amongst contractors that it’s bold to request a payment guarantee. When contracting with a SPV, it would be prudent for a contractor to request a payment guarantee whereby the holding company provides a guarantee to pay the contractor should the SPV fail to do so.  

Current trends 

• In some sectors there’s a move away from the use of bonds or PCGs, so there’s a bigger spotlight on pre-contract award financial due diligence.
• PCGs are often more straightforward to obtain but are not without risk.
• Payment guarantees are becoming more common when SPVs are the client.
• As with any surety or guarantor based outside the UK, the beneficiary would have to obtain a court judgement in the UK, then raise enforcement proceedings in a foreign jurisdiction. Alternatively, an arbitration agreement can be included which allows for easier international enforcement under the New York Convention.
• It's not off-market to try to future proof a project and mitigate potential losses by requesting performance security – whether client or contractor side. 

Next, we will consider the most commonly used form of performance security, retention.

If you would like to discuss performance security and how this may affect your organisation, please get in touch with our team.

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