Price a main contractor failure at each stage of the build, and the 10 per cent bond turns out to be short exactly when failure is most likely.
A 10 per cent performance bond covers a contractor failure only if the extra cost of finishing the job, the remedial work and the delay together stay below the bond plus the retention you hold. On an illustrative £40,000,000 contract that fails at 60 per cent complete, the developer's loss is £5,286,000 against £4,720,000 of bond and retention, a £566,000 shortfall; covering it would take an 11.4 per cent bond. Fail at 20 per cent and the gap is £3,830,000.
Worked in full in The Real Estate Development Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The 10 per cent bond is a market habit, not a calculation. It implicitly assumes that a replacement contractor can be found at a modest premium and that most of the risk sits late in the job, in defects and snagging. Neither assumption is safe in a market where main contractor insolvencies cluster. The question a development manager should be able to answer before signing the building contract is how large the loss would be at each stage of the build, and whether the security package covers it.
| Input | Value |
|---|---|
| Contract sum | £40,000,000 |
| Performance bond, share of contract sum | 10% |
| Retention held on certified work | 3% |
| Stage of completion at failure | 60% |
| Premium charged by a replacement contractor on the remaining work | 20% |
| Remedial work on defective or unfinished packages | £600,000 |
| Re-procurement, legal and consultant fees | £400,000 |
| Delay while the job is re-let | 6 months |
| Land and costs before construction | £12,000,000 |
| Development loan: loan to cost / interest rate | 65% / 8.0% |
| Site security, insurance and holding costs during the delay | £150,000 |
The replacement premium is the assumption that matters most. A contractor taking over a half-built job inherits someone else's design decisions, unknown defects and a supply chain that may not have been paid; it prices that risk, and the premium is usually charged on all the work that is left.
Extra cost to complete = remaining contract value × replacement premium = (40,000,000 − 24,000,000) × 20% = 3,200,000
Cost of delay = debt drawn × rate × months / 12 + holding costs. Debt drawn = 65% × (12,000,000 + 24,000,000) = 23,400,000; interest 23,400,000 × 8.0% × 6 / 12 = 936,000
Total loss = extra cost + remedial + fees + interest + holding costs
| Item | £ |
|---|---|
| Premium on the remaining £16,000,000 of work | 3,200,000 |
| Remedial work | 600,000 |
| Re-procurement and professional fees | 400,000 |
| Interest during six months of delay | 936,000 |
| Holding costs during the delay | 150,000 |
| Loss to the developer | 5,286,000 |
Bond = 10% × 40,000,000 = 4,000,000
Retention held = 3% × 24,000,000 certified = 720,000
Shortfall = 5,286,000 − 4,720,000 = £566,000, 1.4 per cent of the contract sum
Bond that would cover the loss = (loss − retention) / contract sum = 4,566,000 / 40,000,000 = 11.4%
Bond and retention cover 89.3 per cent of the loss at this stage. The shortfall is an unsecured claim in the contractor's insolvency, where recoveries are usually small, so for appraisal purposes it is a loss of profit. On a scheme carrying a 20 per cent margin on cost, it is not fatal; it is also not what the development committee was told when it heard the words "bonded contractor".
| Complete at failure | Certified, £ | Loss, £ | Bond plus retention, £ | Uncovered, £ | Bond needed |
|---|---|---|---|---|---|
| 20% | 8,000,000 | 8,070,000 | 4,240,000 | 3,830,000 | 19.6% |
| 40% | 16,000,000 | 6,678,000 | 4,480,000 | 2,198,000 | 15.5% |
| 60% | 24,000,000 | 5,286,000 | 4,720,000 | 566,000 | 11.4% |
| 80% | 32,000,000 | 3,894,000 | 4,960,000 | −1,066,000 | 7.3% |
| 95% | 38,000,000 | 2,850,000 | 5,140,000 | −2,290,000 | 4.3% |
The exposure runs the opposite way from the usual intuition. A failure early in the job leaves the most work to be re-let at a premium, and that premium dwarfs the extra interest that a later failure carries on a larger loan. The 10 per cent bond is generous at 80 per cent complete and badly short at 20 per cent, which is exactly when a contractor that bid too low is most likely to discover it. The premium matters as much as the timing: at 60 per cent complete a 10 per cent premium leaves a surplus of £1,034,000, and a 30 per cent premium a shortfall of £2,166,000.
Where a 10 per cent bond is all the market will give, the cheaper protections are a parent company guarantee, project bank accounts or direct payment rights over key subcontractors, and a contingency in the appraisal sized for an early failure rather than a late one.
Price the failure at several stages of completion: replacement premium on the remaining work, remedial work, fees and the cost of delay, against bond plus retention actually held. Here the 10 per cent bond covers a failure after about two thirds of the job and falls £3,830,000 short at 20 per cent. The residual appraisal, the risk register and the cost plan interrogation behind this kind of test are in the free workbook for this case.
Usually the developer's proven loss up to the bond amount, typically 10 per cent of the contract sum, until practical completion. In the illustrative case that is £4,000,000 against a loss of £5,286,000 at 60 per cent complete, made up mostly of the 20 per cent premium a replacement contractor charges on the £16,000,000 of work left.
Because the replacement premium applies to all the remaining work. Failing at 20 per cent complete leaves £32,000,000 to re-let and an illustrative loss of £8,070,000; at 80 per cent the loss is £3,894,000. Bond plus retention, £4,240,000 and £4,960,000 respectively, covers the late failure and leaves £3,830,000 uncovered on the early one.
Divide the expected loss less retention held by the contract sum. At 60 per cent complete in the illustrative case that is £4,566,000 over £40,000,000, an 11.4 per cent bond; at 40 per cent complete it is 15.5 per cent and at 20 per cent, 19.6 per cent. Few contractors can provide that, so the rest must come from guarantees or contingency.
This article is one calculation from The Real Estate Development Manager. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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