How to Guarantee Contractor Performance on International Construction Projects: Comparing Surety Bonds with Bank Guarantees and Standby Letters of Credit (2005)

I. INTRODUCTION Major construction projects are complex and high-risk endeavors. The structures that grace our skylines and make our modern world function-office towers, convention centers, museums, hotels, sports stadiums, airports, highways, bridges, tunnels, power plants, and petrochemical facilities, to name but a few-are testaments to our ingenuity and ability to overcome risks. Complexity is inherent in construction. By its very nature, construction is a manufacturing process, but unlike manufacturing a product in predictable environment of a factory, construction is performed outside and subject to elements. Not until structure encloses itself is there any reprieve from nature. Adding to challenges of manufacturing outside, construction projects are on-time events. Things must be done right first time. On large projects,1 sheer number of people and entities that are involved creates yet another layer of complexity. The work force on a major international project can exceed ten thousand during peak of construction.2 Hundreds of companies must be coordinated for project to succeed; these include engineers, architects, contractors, subcontractors, equipment manufacturers, material suppliers, carriers, freight forwarders, financial institutions, and insurance companies. Some of participants are experienced construction professionals, but others are not. The failure of any one of these entities to fulfill their obligations, or opposition from organizations outside project such as governments, non-governmental organizations (NGOs), labor unions, or community groups, can jeopardize success of project. The risks on a project are staggering. First, there are ordinary and significant risks of design errors and construction defects. In addition, there are: (1) physical risks (severe weather, earthquakes, floods, tornados, tsunamis, heat, cold, altitude, and humidity); (2) labor risks (strikes, work slowdowns, riots); (3) human risks (corruption, vandalism, theft, job site safety, and disease3); (4) design and technology risks (using new and untried technology, materials, or processes); (5) site risks (latent subsurface conditions, environmental contaminations, endangered or protected species, archeological or anthropological discoveries); (6) logistics difficulties (congested urban areas, remote isolated sites); (7) supplier and transportation risks (material shortages and delivery delays); (8) regulatory risks (complex government permitting and approval processes); (9) financial risks (cost of capital, inflation, and taxes); and (10) political risks (war, terrorism, government intervention, such as wage and price controls). Other risks associated with foreign projects include working in a multicultural environment, language barriers, visa and work permit requirements, currency exchange risks, international double taxation, barriers to repatriation of profit, and legal disputes arising in multiple jurisdictions. That projects even reach completion given these daunting obstacles is remarkable and a credit to all involved. Contractor insolvency and default is another substantial risk in every project. One noted commentator has remarked that the construction industry is a graveyard littered with bones of insolvent contractors.4 When a contractor defaults, consequences for project can be devastating. An atmosphere of crisis can quickly engulf project. Construction may grind to a halt and overall viability of project may be thrown into question. Every actor on project must respond immediately to such an exigency-subcontractors must decide whether to continue performing work; suppliers, if they are aware of default, must evaluate whether to ship supplies; lenders typically reexamine loan covenants in anticipation of calling their loans; project owner is in unenviable position of trying to avert total disaster and keep project on track. …