By Lucien Mundie, CEO, Unison
In the dynamic and often high-risk environment of South Africa’s construction sector, construction guarantees serve as critical instruments for risk mitigation, financial stability, and business growth.
These guarantees, particularly performance, advance payment, and retention guarantees, are more than just regulatory or contractual requirements; they are the foundation of trust, efficiency, and competitiveness in the industry.
Financial security for employers – At their core, construction guarantees offer employers vital protection against non-performance, delayed completion, or defects in execution. In the unfortunate event that a contractor defaults or fails to meet project obligations, the employer can call on the guarantee to access immediate funding to rectify or complete the works. This eliminates the need for costly and time-consuming legal processes, allowing the project to proceed with minimal disruption.
This security is especially valuable in large infrastructure projects where timelines, budget adherence, and quality standards are critical. Employers gain the assurance that their investment is safeguarded, and they have a fallback mechanism to ensure continuity and delivery.
Independent and reliable protection – One of the defining features of construction guarantees is their independence from the underlying contract. Once a guarantee is issued, typically by an Insurer or a Bank, it becomes a standalone financial instrument. This means the issuer cannot dispute payment based on issues related to the main contract, unless there is clear evidence of fraud.
This independence enhances the enforceability of the guarantee, providing employers with the confidence that, should it be necessary, the guarantee can be called upon swiftly and without legal entanglements. This certainty reinforces effective project risk management and allows both parties to operate with clarity and peace of mind.
Enabling growth for contractors – For contractors, particularly small to medium-sized firms, construction guarantees offer a gateway to larger projects. Unlike traditional bank-issued bonds that often require full collateralisation, construction guarantees typically require far less, around between 15% and 30% (Dependent on the assessment of key aspects of a Contractor) % of the guarantee value. This reduced collateral burden ensures that contractors can retain working capital to manage day-to-day operations and fund multiple projects concurrently.
With guarantees usually set at between 10% – 12.5% of the contract value, they strike a balance between providing security for employers and flexibility for contractors. By lowering financial entry barriers, they enable broader market access and promote inclusivity and transformation within the sector.
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An implicit professional endorsement – The willingness of a reputable financial institution to issue a construction guarantee on behalf of a contractor speaks volumes. It reflects a third-party endorsement of the contractor’s financial health, operational capacity, and credibility. This endorsement gives employers added confidence and positions the contractor as a reliable partner, increasing the likelihood of successful project bids and ongoing relationships.
In an industry where reputation is everything, the backing of a recognised guarantee provider enhances the contractor’s brand and standing in the market.
Tax and financial planning advantages – Beyond operational and reputational benefits, construction guarantees offer distinct financial planning advantages. The premiums paid for guarantees are treated as insurance expenses, making them tax-deductible and contributing to more efficient cost structures.
Moreover, any funds provided as collateral often earn interest and are returned once the guarantee expires or is no longer needed. This ensures that contractors can manage their reserves wisely, reinvesting capital into future projects or business development initiatives.
Promoting project success and industry reputation – Ultimately, construction guarantees are instruments of accountability. They help ensure that projects are completed to the required standard, that defects are addressed, and that all contractual obligations are met. In doing so, they support not only individual project success but also the broader reputation of South Africa’s construction industry.
A sector known for consistency, transparency, and reliability is far more attractive to investors, both locally and internationally. The widespread use and enforcement of guarantees help raise the standard of practice and set a precedent for responsible delivery.
Practical considerations – While the benefits of construction guarantees are clear, their effective use hinges on careful attention to detail. Calling up a guarantee must be done in strict accordance with the terms outlined in the document (Guarantee wording). Any deviation, however minor, can result in the claim being rejected.
It’s also important to select the right type of guarantee for the risk at hand. Performance guarantees address project execution, advance payment guarantees protect employer pre-financing, and retention guarantees cover post-completion risks such as latent defects. Using the correct instrument ensures that the guarantee serves its intended purpose and offers meaningful protection.
Also important to note is that not all guarantee wordings result in immediate payment. Suretyship worded guarantees (also called Conditional Guarantees) are more accommodating of a dispute in terms of a contract, whilst an “on demand” unconditional guarantee, does not consider a dispute between the contractor and Employer and does not require a default, leading to faster payouts.
Legal clarity and industry confidence – Recent legal developments in South Africa have reinforced the enforceability and independence of construction guarantees. Court rulings have clarified that, except in cases of proven fraud, issuers cannot dispute payment based on contract disputes. This legal certainty provides confidence to all stakeholders and encourages the continued use of guarantees as a standard practice.
Construction guarantees are not merely contractual requirements, they are strategic tools that support financial stability, enable market access, and promote industry professionalism. For employers, they offer a dependable safety net, for contractors, they unlock opportunity and enhance reputation.
As South Africa continues to invest in infrastructure and development, the widespread adoption and understanding of construction guarantees will play a key role in ensuring that projects are completed on time, on budget, and to standard, benefiting all stakeholders and strengthening the foundation of our construction industry.
Editor’s note: In a follow up article, we will discuss in more detail the differences between Suretyship or Conditional Guarantees and On-Demand or Unconditional Guarantees.