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Bonding over bonds

By: Peter Gosnell
02 November, 2010

Feature of the week: On the 21st of September this year, a judge in the NSW Supreme Court dismissed a claim of unconscionable conduct against millionaire publican Justin Hemmes.

The case was brought by building firm Lucas Stuart as Hemmes sought to convert a $1.6 million performance bond lodged by the builder into cash.

Hemmes and Lucas Stuart have been in dispute over defects and delays to Hemmes' $65 million Ivy Nightclub project in George Street, Sydney for more than a year, and the failed unconscionable conduct action comes as Hemmes pursues his own $11 million counter claim in regards to the alleged defects.

Given the messy nature of this dispute, construction clients are unlikely to lose their affection for performance guarantees anytime soon. But since the global credit crunch, the building and construction industry has found funding for bonds harder to come by.

Twelve months ago corporate services firm KPMG produced a report titled "Bonding Issues Faced by Construction Companies in Australia."

The report was commissioned by the Australian Constructors Association and painted a picture of an industry in danger of strangulation.

"The Global Financial Crisis (GFC) has led banks, who are the main providers of performance guarantees, to restrict their supply and to increase their price," KPMG said.

"Banks have found it more difficult and expensive to raise the capital they need to back performance guarantees, which have been relatively unprofitable in their own right."

But that wasn't the only GFC-related phenomenon putting pressure on construction firms.

"The difficult economic climate means that clients are unwilling to relax their requirements for performance guarantees or bonds. For some more complex projects, clients require both a higher amount of the performance guarantee or bond as a proportion of the construction contract value and a longer period for which the contractor has to provide it."

Add to this diminished competition, as foreign lenders departed from the Australian marketplace, and twelve months on from that report, the question is: what, if anything, has changed?

David Hudson is Executive General Manager for Risk at listed construction giant Leighton Holdings. He told IndustrySearch the price of bonding had escalated in the wake of the GFC, rising three hundred percent as banks passed on the higher cost of their own borrowings.

"Here we are, twelve months on, and the world has stabilised," Hudson said. "Pricing has come down about 20%, but it is still twice what it was say two and a half years ago."

According to Hudson, the pricing reduction may have been a result of insurance companies coming into the bonding market, and filling some of the gap left by departed foreign lenders. But even that solution came with issues attached.

"The issue is that you have to be very persuasive with your clients to get them to accept insurance bonds," he said

"Everybody's used to bank guarantees. In some institutions there is a reluctance to accept insurance bonds, but they are a very legitimate instrument, and really need to be supported, because they bring more competition into the market.

"Bonding is like the lifeblood of the construction industry and various contractors have differing abilities to retain bonding capacity. If clients become overly choosy, it actually limits a contractor's ability to respond, and therefore could well limit the competitive market," he said.

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