19/09/2021
Bank Guarantee Issuance vs Retention SUM
In this article I want to share the differences between Bank Guarantee issuance and Retention Sum. Before we move into discussing the differences between the two, let us first understand what are these instruments.
Let’s say today you (the “contractor”) have successfully been awarded a contract from an awarder, be it private or government bodies. Normal contract practice is that the awarder requires you to give them a performance security before commencement of the job in the form of Bank Guarantee/ Insurance Guarantee/ Security Deposit/ Retention Sum. This form of security is to partly secure the awarder in the event the contractor does not perform/ is unable to form full/ part of the contract works. The amount of security differs from type of awarder ranging between 5-10% of the total contract amount, usually the contract awarders set the minimum of 5% security.
Definition
Bank Guarantee (performance) – Is a form of financial letter of guarantee produced by local banks/ foreign banks/ insurance company providers (some awarders have stated clearly in the letter of award, BG’s are only acceptable by financial institutions “FI” recognized by the awarder). This letter of guarantee serves as a performance guarantee in the name of the contractor to be served to an awarder, guaranteeing an agreed amount to be paid to the awarder in the event non-performing/ termination of the contractor for contract works. This guarantee will remain valid from commencement of the contract tenure until completion/ expiry of contract tenure. Extension of Time (EOT) is considered part of contract tenure.
Retention Sum – Is a form of security arrangement made between the contractor and awarder. This arrangement is where the awarder make deduction in claims from the start of the contract tenure until reaching the required security amount which is called retention sum or some other places call retention monies. The deduction from claims amount varies per awarder ranges between 5-10% per claim which to be collected reaching up to full retention sum amount 5-10% of total contract amount as set by the awarder. The sum will then be held by the awarder and will be released to the contractor after defect liability period/ warranty period.
Issuance Procedure
Bank Guarantee (performance/advance payment/ tender) – for issuance of Bank Guarantees, the Contractor will have to submit their application together with all the necessary documents as required by the issuing institution such as Letter of Awards and Bank Guarantee format.
The procedure for issuance of guarantees by institutions normally take around 5-7 days (sometimes longer) depending on the amount and the type of contract. The FI will assess the contractor based on its past experience, financial standing and also awarder background in overall before allowing any issuance of guarantee. Once approved by the FI, they will lay out all the terms and conditions required before issuance of such guarantee. The FI will also charge a certain fee called an issuance fee which is charged based on the tenure of guarantee which is also required upfront.
Retention Sum – is not as complicated as bank guarantee issuance, as the awarder will usually require the contractor upon 14 days of acceptance of LOA, to write in verbally towards the awarder stating that the Contractor has opted for Retention Sum deduction from claims.
Claim Procedure
As the contract progresses, eventually the contractor failed to deliver as per contract requirement. Thus the awarder will terminate the contractor and claim for whatever liable to the awarder. This includes liquidation of guarantee/ retention sum. The Guarantee can be claimed by the awarder at any point of time within the contract period if the contractor fails to deliver and is in breach of contract terms.
Bank Guarantee (Performance) – Awarder will issue a notice letter towards the issuer of guarantee informing the termination of appointed contractor and claim of Guarantee. The issuer will then within 14 days release an amount equivalent to the guaranteed amount towards the awarder. If the Bank Guarantee is not fully secured by the Fixed Deposit or any other financial security, the contractors have to pay to the FI of the differential amount. If remain unpaid, the institution will take recovery actions to recover the claim amount which will involve legal actions/ recovery options set by the FI.
Retention Sum – the retained amount by the awarder will not be released by the awarder and will be rightfully collected by the awarder as per contract terms. In the event the retention sum was not fully collected, the awarder may opt to retain whatever certified claims to be paid to the contractor to cover the full retention sum, if also not sufficient, the awarder may also claim the difference amount from the contractor via letter of demand/ legal actions.
PROS and CONS
Bank Guarantee :
Pros
Smooth Contract Cash flow
No claims withheld by the awarder upon completion of contract works
Cons
Requires Upfront Security
Tedious issuance process
Yearly commission fees involved
Retention SUM:
Pros
No upfront security
No hassle process for retention sum option
No commission fees involved
Cons
Claims held up to 10% throughout the contract duration
Possibility of long delay in receipt of full retention sum after DLP/ Warranty period
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