On-Demand Performance Bonds: Time for a Re-Think

The process of building construction is often a complex and costly endeavor, highlighting the need for measures that ensure project completion to desired outcomes. One effective measure to accomplish this is through the use of performance bonds, which are legal documents issued by insurance companies or banks. These bonds serve as a guarantee of payment of an agreed-upon sum in the event of a party failing to comply with its contractual obligations on a project. Performance bonds serve as a safety precaution against unscrupulous contractors. If a contractor fails to fulfill the terms of their contract, the business owner or government agency can file a claim against the bond, which allows them to recover any financial losses they may have incurred.

However, not all performance bonds are created equal. In the United Arab Emirates (UAE), there are two major types of performance bonds: conditional and on-demand bonds. Conditional bonds require a client to provide evidence that the contractor has not fulfilled their contractual obligations. In contrast, on-demand bonds have no such requirements, meaning a request for payment can only be refused if it is openly fraudulent or dishonest, which is not always immediately obvious until litigation has started. The GCC primarily uses on-demand performance bonds, while other jurisdictions like the UK and Canada primarily use conditional bonds.

The widespread use of on-demand performance bonds in the GCC has had a negative impact on the construction industry in recent years. Many project owners have abused these bonds to address their cashflow issues, leading to a wave of unsubstantiated and bad faith demands for payment on performance bonds across the region. This trend has resulted in contractors going bankrupt due to these cases and being stuck in litigation fighting against false claims made by their clients, which can be both expensive and time-consuming. The COVID-19 pandemic already had a sizable impact on construction projects, which resulted in declining profits all around. This abuse of the system has also driven away many international contractors, who now view the GCC market as a liability. It is imperative to address this issue and create a better work environment for the construction industry to avoid long-term repercussions.

Although on-demand performance bonds may benefit owners in the short term, they ultimately harm the industry as a whole in the long term. Contractors should serve their notices under building contracts, request extensions of time, and progress those requests for time and money to protect their financial position and bonds. Most importantly, contractors and owners need to work together to create a fair and equitable relationship that fosters a better work environment for the construction industry. While this will be a challenging task, it is necessary for the long-term success of construction in the GCC.