Local Government Contracts: Performance Bonds and Guarantees (Hansard, 24 July 1996)

Earl Ferrers

On 28th September 1995 the Department of the Environment issued a consultation paper on the use of performance bonds and guarantees in the letting of contracts for work carried out under the compulsory competitive tendering regime. Comments were received from 157 local authorities and other interested parties. The Scottish and Welsh Offices issued separate consultations receiving 16 and 13 responses respectively. My right honourable friends the Secretaries of State for Scotland and Wales will be issuing separate guidance which will be on similar lines to that issued in England today.

The Department of the Environment has always accepted that authorities may properly require performance bonds or guarantees from contractors where there is perceived to be a significant risk entailed in awarding work to a contractor. However, there had been some concern that some authorities might be misinterpreting the need for bonds and guarantees and, as a result, competition might be restricted, distorted or prevented. The paper sought to set out how the risk of this could be reduced.

The principle underpinning the consultation paper was that authorities should consider the requirement for a bond or guarantee on a case by case basis via a proper risk assessment. The process should be transparent, with the authority being able to demonstrate to the Department of the Environment, if necessary, how it arrived at a particular decision.

138WA

The paper specifically requested comments on three particular points. The first concerned the legitimacy of using both bonds and guarantees. It has been argued by certain authorities that requiring both of these instruments is acceptable as they serve different purposes. However, we remain of the view that the net effect of imposing both on a contractor will often be excessive and unreasonably inhibit the field of competition. We therefore advise authorities against such an approach.

Secondly, comments were sought on the adequacy of a limit of 10 per cent. of the contract value on the size of the bond. We have decided that imposing such a figure would not be appropriate. While it was generally agreed that a figure of 10 per cent. would usually be adequate cover, we accepted that there may be circumstances where it is not. It is important, however, that authorities recognise that requiring too high a bond may influence competition and value for money and that they will have to justify the level of bond they set if challenged.

Thirdly, some contractors have argued that the notional premium added to the authority's bid during the tender evaluation exercise should equal the average, rather than lowest, cost of obtaining a bond. However, we are willing to accept that such a measure may have acted as a disincentive to authorities to invite a wide spectrum of contractors to tender, as one particularly high bond could have a disproportionate effect on the average value. We have therefore decided that the notional premium should remain set at the lowest cost of obtaining a bond.

A list of responses to the consultation proposals has been placed in the Library of the House. Copies of the responses are held in the Department of the Environment's library.