DG Entreprise Competitiveness of the Construction Sector ALT Working Group, Phase II

CONTRACT BONDS TASK GROUP INTERIM REPORT

REVISED VERSION

Members of the Task Group DG Entreprise, Dg Internal Market, govt/UK, govt/NL, CEA, CEETB, EBC/CNC, FIEC, FIEC/ANCE, FIEC/FFB, FIEC/ NACEBO, EIC, ICIA/ISA, Background to the Contract Bonds Task Group The Working Group on Abnormally Low Tenders, with the participation of experts from Member States, started its second phase of works on 4 February 2000. At the meeting it was decided to set up a Contract Bonds Task Group to further study the recommendations for the prevention, detection and elimination of ALTs of the report of the Working Group (chapter 7, 8 and 9). Mission of the Task Group Based on chapter 7.7 of the report the Task Group agreed on the following Mission Statement: To study existing systems of contract bonds and consider how such systems contribute to prevention, detection and elimination of Abnormally Low tenders. If so, to study how any such successful systems could be developed or adapted as an appropriate and efficient system for the European Market, taking into account the interest of SMEs. Works of the Task Group The Contract Bonds Task Group has had three meetings so far dealing with the first part of its mission namely the study of existing systems of guarantees or bonds in use in Europe, in North America and other systems such as the Uniform Rules for Contract Bonds of the

International Chamber of Commerce adopted by Japan and international organisations such as the UNCITRAL and the World Bank.

1. Existing practices in Europe

The study of existing systems of contract guarantees in Europe, based on the information provided by participants, permitted to draw the main features of such systems and to comment on their impact on preventing, detecting and eliminating Abnormally Low Tenders. For a matter of clarification, it was specified that contract guarantees exist in the form of bank guarantees or surety bonds. Whereas a bank guarantee is an unconditional obligation to pay the beneficiary, in many instances on demand, the surety bond, issued by an insurance company, is a conditional obligation attached to the completion of the underlying contract. A bank guarantee usually is payable under presentation of a written demand by the beneficiary without having to establish any breach of contract. A surety bond only is payable when a breach of contract has been established. It was noted that bank guarantees, directly affecting the credit line facility of the contractor, are detrimental to SME. Main Features: Contract guarantees in the form of performance, advance payment and maintenance guarantees are widely used in the public sector in the EU. Bid guarantees are seldom used. Various guarantees usually amount to 5/10% of the contract value. In some countries performance bonds for a higher percentage (over 20%) are in use: in France, 100% in the private housing sector - in Italy: for public contracts superior to Euro100million (Garantia globale dexecuzione). There is no harmonisation of guarantees/bonds in European countries. The legal definition, percentage, duration and legal obligations substantially vary from one country to another. Guarantees are mostly issued by banks. Bonds issued by insurance companies are also accepted in most countries. Impact on ALTs: It is generally recognised that existing systems have no visible impact in preventing, detecting or eliminating ALTs. 2

In most countries, guarantees issued by banks adversely impact on the credit facility of SME as opposed to bonds issued by insurance companies. Existing systems do not guarantee that the contract will be completed in time, according to specifications and at no extra cost for the client.

2. The North American systems of Contract Bonds

In the US and Canada similar contract bonds systems have been in place for a long time over a hundred years in The US. Their main features and impact on ALTs were examined and discussed by the Task Group. Main features: It is a comprehensive contract bonds system, applied at Federal and States level, to guarantee the completion of public contracts and protect public money. It consists in a bid bond, a performance bond and a payment bond issued by insurance companies. Legal obligations under the bonds are tied to the underlying contract. The bid bond (5% of the contract value) guarantees that the contractor awarded the contract will sign it. The bid bond provides financial assurance that the bid has been submitted in good faith and that the contractor intends to enter into the contract at the price bid and provide the required performance and payment bonds. The performance bond (100% of the contract value in the US and 50% in Canada) guarantees the performance of the contract time, quality and price. The performance bond protects the owner of the contract from financial loss should the contractor fail to perform the contract in accordance with the term and conditions of the contract documents. The payment bond (100% of the contract value in the US and 50% in Canada) guarantees the payments due by the general contractor to sub-contractors and suppliers. To increase the access of SME to contract bonds, the Small Business Administration (SBA), since 1988, has developed an extremely successful Surety Bond Guarantee (SBG) program. Sio@sio.org

Impact on ALTs and comments: The bid bond contributes to the prequalification of contractors participating to the tender, based on their technical capacity, experience and financial resources. If the offer is not serious the contractor will not obtain a bid bond. The bid bond also contributes to more transparency in the bid procedure and therefore to the elimination of ALTs. Under the performance bond, the insurance company has the obligation to pay for the completion of the contract. If an Abnormally Low Tender is an increased risk of default of the contractor and of additional cost to complete the contract, the contractor making an ALT will not get a performance bond. Thus the performance bond will contribute to the elimination of ALTs from the tender procedure. Sub-contractors, SME and suppliers are protected by the payment bond against the default of the general contractor that may be the consequence of an ALT. The system provides an efficient protection to the client, the Administration and the taxpayers money.

3. International practices
Uniform Rules for Contract Bonds (URCB) of the International Chamber of Commerce (ICC) The rules were developed to regulate the provisions of conditional guarantees and to emphasise that the obligations of a guarantor were accessory to and co-extensive with the obligations of the contractor under the contract to which the relevant bond relates. The rules are intended to provide a cohesive general framework based on clear definitions. Their application can be modified or amended if this is considered appropriate in the case of any particular contract. In particular it is up to the parties involved in the contract to fix the percentage and the validity period of the bond. Japan adopted the rules as a legal general framework for the new contract bonds system introduced in 1996. The United Nations Commission on International Trade Laws (UNCITRAL) recently adopted the rules that are also referenced by the World Bank.

4. Present position of the Task Group

It should be noted first that the Task Group, in the light of the information available, has completed its mission regarding The study of existing systems of contract bonds and consider how such systems contribute to prevention, detection and elimination of Abnormally Low Tenders. The Group recognised that present systems of contract guarantees in Europe do not contribute to the prevention, detection and elimination of ALTs. However in the course of the study opinions expressed by members of the Group were divided on the impact of any systems of bonds on Abnormally Low Tenders. Whereas it was generally acknowledged that the North American system offers substantial advantage for the protection of public investment and better transparency in the tender procedure, there was not a clear majority expressed on its recognised impact on ALTs. FIEC, in particular, expressed concerns on the cost for SME to have access to the system. CEETB estimated that there was not a clear relation between contract bonds and ALTs and also that they would be no defence against a single isolated ALT. However CEETB shared the view expressed by Mr Tomaras, DG Market, that contract bonds could serve as a very effective antidote against a contractor submitting ALTs as a matter of business policy. In that case contract bonds would have a long term effect in discouraging ALTs practice. IEC estimated that contract bonds should very seriously be considered by contractors as a valuable alternative to on demand bank guarantees and recommended to further study a system of contract bonds based on the Uniform Rules for Contract Bonds (URCB). EIC Position Paper on Contract Bonds is attached to this report (schedule X). CEA expressed the following opinion: Different points of view have been expressed in the Task Group on the positive short term effects which a generalised recourse to contract bonds, adapted to European practices, would have on ALT. These effects could only be really measured after several years. In the framework of its mission, it is not up to the Task Group to envisage the immediate consequences that a European system of contract bonds, in the field of public works, offers on the protection of public investment, transparency, equality of undertakings and the safeguarding of the interest of SME. But it would be preferable to undertake this examination in another context. Hence, regardless of the outcome of the consultation of national federations, should the Task groups report be considered as finished? Its work should continue with the strict aim of processing ALT..

ISA, represented by ICIA, indicated that extensive experience of its North American members does suggest that apart from its primary function of protecting the taxpayers money and ensuring that bonded projects are completed, performance bonding does add a Good Practice value, in that it contributes to the detection and thereby potential mitigation if not elimination of ALTs. ISA reinforced the view of Mr Tomaras and CEETB relative to the long term beneficial effect of contract bonds and also supported EIC recommendation concerning URCB. Therefore ISA strongly supported the creation of a suitable forum to further the European contract bonds project. On account of comments made by members, questions were raised on whether studies on the possible adaptation of the North American system or any other system to the European Market should be pursued by the Group. As a consequence, the Task Group decided to prepare an interim report for its members to consult their national federations and to present it to the Working Group on ALTs, looking for guidance for its future works.

Attachments: URCB Rules EIC Position Paper ..

YP, ICIA 11/2000