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News & Press: 2012 News Items


Tuesday, 16 October 2012  
Posted by: Bert vd Heever
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Question: Could you please elaborate on the reasons for the provision of guarantees rather than retention and how the quantum of the guarantees is determined?

Answer 1: In addressing your query I would like to stand back and consider the security issue as a whole in relation to the building contract. Firstly it must be appreciated that it is impractical for the parties should seek "absolute" security from each other. Assuming no change in the contract sum this would result in the employer and contractor each providing a 100% guarantee of the contract value on a reducing basis to each other over the period of the contract. This is obviously commercially impractical and unreasonable.

The practical and reasonable route is therefore to seek financial cover at a level that will potentially (but not absolutely) "guarantee" the potential risk due to the failure of the defaulting party not meeting its obligations. Experience and financial practicality over many years have shown that security cover not exceeding 12.5% of the contract sum is reasonable and affordable in almost all instances. It is appreciated that the employer's risk reduces as the project is built and therefore the security can likewise be reduced at definable points. This is addressed in the Variable Construction Guarantee in terms of 14.3

In the past it has not been customary or thought necessary that the employer (no matter how financially stable he may appear to be) should, in turn, provide security to the contractor. Correctly this unfair practice is addressed in the JBCC contract. However there is much debate on the quantum of cover that is seen as being reasonable with the industry "ducking the issue" on setting criteria for such a guarantee. For better or worse I have analysed the issue and have come to the conclusion that the cash flow to the contractor represents the highest unsecured risk and therefore should be the focus in determining the quantum of such guarantee. In addressing the above I am of the opinion that the two highest contiguous projected cash flow months to the contractor should form the basis of the guarantee provided that such amount should not be more than 12.5% of the contract sum. This method seems to provide a practical solution in most instances and should be addressed in the Payment Guarantee in terms of 3.1

The need for an Advance Payment Guarantee (see 14.5) is principally due to the fact that a "Transfer of Ownership" for materials or equipment is bad in law where the party providing such is not the rightful owner of such materials etc. The provision of the guarantee will invariably require the contractor or subcontractor to offer some form of collateral to the provider of the guarantee. The JBCC agreements deal with such guarantees as part of the payment process which significantly simplifies and improves the financial administration and control of the project.

Retention can only be applied to the party due to receive payment being the contractor and in turn the subcontractors. Retention's primary disadvantages to the employer is that at the start of the works the employer's "cover" is minimal and further also increases the risk of the contractor and subcontractor's defaulting due to their reduced cash flows.

(Questions and answers obtained from the Frequently Asked Questions published on the JBCC website)