Geoff Parish as at 13th August 2017

6812 2017 E7-8-15-17-Insurance & Bond + ANSWERS

Contract Administration CONS 6812 - Class exercise No.8 GUIDE ANSWERS

These Topics are Bonds and Insurance Tuesday 15th August 2017

I am interested in answers that show you have thought extensively about the question.

NZS 3910 applies to all building contracts relevant to the following questions: where there
are blanks, you must fill them in with the appropriate letters:

Q1. What is the purpose of a bond? A bond is provided by a third party with substantial financial
resources who offers to pay up to a specified $ limit to A in a contract with B if B is in default of its
obligations under the contract such as to cause A financial loss.

Q2. What is a bondsman? An American term used to describe the third party entity in Q1. Bonds are
in more common usage in the US for construction work in the US than in NZ and for larger $ values.
A Bondsman also provides bonds for people accused of committing crimes who are given bail while
waiting to appear in Court. If the accused fails to turn up in Court on the appointed time the
bondsman pays the amount of the bond into Court.

Q3. What two types of financial entities typically act as a bondsman? Banks and insurers in NZ.

Q4. The building contract may require a performance bond to be taken out in favour of the
Principal where the Bondsman pays the Principal if the Contractor is in default in its
performance under the contract to complete the Contract Works.

Q5. The building contract may require a performance bond to be taken out in favour of the
Contractor where the Bondsman pays the Contractor if the Principal is in default in its
performance under the contract to pay for the Contract Works.

Q6. Which is the most common scenario, the one in Q4. or the one in Q5.? Q4.

Q7. What is the essential difference between a typical performance bond and an on demand bond?
The following information from an International Bar Association paper may help:

Rupert Choat and Aidan Steensma

CMS Cameron McKenna, London

familiar feature of the construction industry internationally is the performance bond

(that is, a form of security, generally procured by a contractor for an employer,
consisting of an undertaking by a bondsman or surety to pay the employer in specified
circumstances). In an area where ambiguous terminology abounds, there are two main
categories of performance bond: conditional and on-demand or unconditional, which
differ as follows:

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Geoff Parish as at 13th August 2017
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Under an on-demand bond, the bondsman (often a bank) is required to pay

whenever the employer demands payment in accordance with the terms of the bond,
without proof of default under the underlying construction contract. Like many legal
systems, under English law it is traditionally said that a bondsman can only refuse to
make payment on a compliant demand if the demand is made fraudulently.
Under a conditional bond, the bondsman is only required to pay out if the
contractor is proved to be in default under the underlying construction contract. They are
more often called guarantees, with the providing party a guarantor or surety. English
law protects guarantors from having to pay out far more than on-demand bondsmen. In
particular, many changes to, or affecting, the underlying contract discharge the
guarantor unless he consents (hence so-called indulgence clauses in many guarantees
provide consent in advance).

The bondsman pays up the full amount of an on demand bond if the beneficiary demands payment
and the bondsman recovers its loss from the security the bonded party provided to secure the bond,
without which [usually being the Contractor], it would not have secured the construction contract. I
have taken out several on demand bonds with the ANZ Bank which can be trusted, for construction
contracts for equally trustworthy clients. I would not do this with a private client, only a publicly
funded entity.

A straightforward performance bond, usually with an insurance company, requires the beneficiary to
prove loss caused by the bonded party before it will pay anything out. These bonds cost more
because the bondsman cannot recover its loss from the bonded party.

For fuller details on CONSTRUCTION PEFORMANCE BONDS go to:

file:///C:/Insurance%20&%20Bonds/Insurance%20-%20Bonds%20-%20Performance%20-
%20Lucy%20Bushell%20and%20Philip%20Vaughan.pdf

Q8. What is the most likely cause of default by the Principal and the Contractor? Insolvency

Q9. What is a bid bond [refer: http://en.wikipedia.org/wiki/Bid_bond for help]? Tenderers are
required to take out a bid bond before being allowed to submit a bid. A tenderer forfeits the
amount of the bid bond if it withdraws its bid. The object is to encourage tenderers to take the
bidding process more seriously, and be less inclined to withdraw their bid if they see for
example that their bid is significantly lower than anyone elses bid.

Q10. If the Contractor does not want retentions held on progress claims what alternative
arrangement can be made? The Contractor can provide a retentions bond instead of having
retentions held against it. See for example Schedule 5 NZS 3910.

Q11. If the Contractor does not produce a bond within the contract time limits what action
can the Principal take to encourage the Contractor to produce a bond? Not pay, see for
example 3.1.4. NZS 3910.

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Q12. If the Principal does not produce a bond within the time limits set out in the contract
what action can the Contractor take to encourage the Principal to produce a bond? Suspend
work, see for example 3.2.3. NZS 3910.

Q13. What are the two common likely cause of loss or damage to the work under construction? Fire
and Water

Q14. If the contract is to construct new work which party does the contract typically require to
Insure the work in progress? Contractor

Q15. If work in progress is damaged by one of the two risks specified in Q13. which party bears that
risk i.e. which party is responsible for repairing damaged work at its own expense? Contractor

Q16. What is the normal method of offsetting the risk of an occurrence with adverse consequences
which will be costly if it happens, but there is a good chance it will not occur? [See Q14.]
Insurance

Q17. If the party named in Q15. bears the risk of repairing damaged work at its own expense,
why does the other party require the action described in Q16. to be carried out? Having been
paid for the work already done the Contractor is unlikely to be able to do it a second time at its
own expense and may become insolvent if it tries to.

Q18. If the contract involves renovating, extending, or modifying existing buildings which party does
the contract typically specify should insure the work in progress? Principal

Q19. Why does the contract make the party specified in Q18. insure the work in progress? Existing
buildings will already be insured against loss and damage and it is easier to extend the existing
policy to cover the building work.

Q20. Is it possible under normal circumstances for the Contractor to insure against the
consequences of its own negligence, Yes or No? No

Q21. Besides the risks established in Q13. to the work in progress what other risks are typically
insure against? Typically loss of support [when the next door building falls into your hole in the
ground also removal of loadbearing brickwork construction adjacent party walls and faced
retention work and other work involving demolition] vibration [when the vibration from the
piles you are driving into the ground cause the building next door to crack, theft, vandalism,
and Force Majeure. See 5.6.6 NZS 3910 for uninsurable risks without special provisions in an
insurance policy.

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Q22. Assume the contract value is $10,000,000 which includes $1,000,000 for the piling and
foundations? The work in progress is insured for a contract value of $9,000,000 because
the insured reasons that if a Q13. risk occurs the piling and foundation work will not be
affected. A Q13. risk does occur and the resulting damage costs $4,000,000 to repair. How
much will the insurer pay the insured and why? $3,600,000 [less any excess in the policy]
because having insured 90% of the value of the contract works the insured will pay 90% of the
cost of repair. Legislations stops this applying to homeowners who under value their home or
house contents.

Q23. Why are insurance policies taken out in joint names for construction work? Only a party to an
insurance contract/policy can claim under it. Typically joint names equals Principal and
Contractor, if one is insolvent the other can still access the insurance policy for cover. See
8.2.3(b) NZS 3910 for example. For Contractor it is useful to add and its Subcontractors.

Q24. Do joint name insurance policies cost more than single name insurance policies, Yes or no? No

Q25. Explain why you answered yes or no to Q24.? It makes no difference to the insurer who makes
the claim as regards how much it pays out, only as to who it makes payment to.