Types of financial guarantees for investments and large business projects

Financial guarantees for business projects are contractual arrangements designed to manage and mitigate risks.

Guarantees provide assurance to stakeholders, such as investors, lenders, and project owners, that all obligations related to a project will be fulfilled. They serve as instruments to secure funding, protect the project against potential losses in the event of non-performance.

If you are planning a large project and are looking for comprehensive professional support, financing and guarantees, contact our team for a consultation. We and our partners have extensive experience in project financing in the construction industry, heavy industry, mining, chemical industry, agriculture, oil and gas sector and other industries.

Classification of financial guarantees related to large investments

The use of financial guarantees has a historical foundation dating back centuries.

As trade and commerce evolved, so did the need for assurances in financial transactions:

• Maritime surety bonds: In the 1800s, surety bonds were used in maritime trade to guarantee the performance of shipowners and protect cargo owners against financial losses.

• Construction industry: Performance and payment bonds became gold standard in the construction during the 20th century. Governments and private entities required contractors to provide these guarantees to ensure project completion and payment to subcontractors.

• Corporate bonds and credit enhancement: In the modern era, financial guarantees have expanded beyond construction to various sectors. Corporate bonds and credit enhancements, such as collateralized debt obligations (CDOs), have become integral to financial markets.

In large projects, these financial guarantees help manage risks, build trust among stakeholders, and ensure that the project is completed according to the agreed terms.

The type of guarantee required depends on the nature of the project and the contractual agreements between the parties involved.

The following classification of financial guarantees related to large investments is based on the distinct purposes and objectives that these guarantees serve. Each large group in this classification addresses specific needs and concerns in investment landscape, providing a structured framework to understand the diverse range of financial instruments designed to manage risks, enhance creditworthiness, and fuel investment.

Table: Main types of financial guarantees commonly used in large projects

Main types	Purpose	How it works
Performance bonds (surety bonds or completion bonds)	Issued to ensure that the contractor completes the investment project according to the terms and conditions of the contract.	The bonding company guarantees that the contractor will perform the work as specified, and if the contractor fails to do so, the bonding company will compensate the project owner.
Payment bonds (labor and material payment bonds, subcontractor bonds)	Issued to guarantee that the contractor will pay subcontractors and suppliers for the work and materials provided.	If the contractor defaults on payment obligations, the bonding company steps in to ensure that subcontractors and suppliers are compensated.
Bid bonds (tender bonds, bid securities)	Issued to guarantee that a contractor will honor their bid and enter into a particular contract if awarded.	If the contractor refuses the project after winning the bid, the bonding company compensates the project owner for the difference between the winning bid and the next highest bid.
Advance payment guarantees (advance payment bonds, advance payment securities)	Issued to guarantee the repayment of an advance payment made by the project owner to the contractor.	If the contractor fails to perform or complete the project, the guarantee ensures the repayment of the advance payment.
Retention guarantees (retainage bonds or retention money guarantees)	Issued to guarantee the release of retention money held by the project owner during the project.	The guarantee ensures that the contractor fulfills all post-completion obligations, and if not, the retention money is compensated.
Financial guarantees for environmental obligations (environmental performance bonds, ecological surety)	Issued to ensure the financial capability of an investment project entity to fulfill environmental obligations.	These guarantees may be required to cover the costs of environmental cleanup or remediation if the project causes environmental damage.
Completion guarantees (project completion bond, timely completion guarantee)	To guarantee that a project will be completed within a specified timeframe.	If the project is not completed on time, the guarantor may be required to compensate the project owner for damages incurred due to delays.

This classification is also grounded in the varied requirements / challenges associated with large-scale projects and investments, reflecting the evolving nature of financial markets and the dynamic relationship between investors, lenders, and project developers.

Performance bonds

A performance bond is a common type of financial guarantee that ensures that a partner fulfills its contractual obligations under a project or other agreement.

It is commonly used in the construction industry, although it can be applied in various sectors.

Performance bonds play a crucial role in mitigating risks in large projects, providing financial security and confidence to project owners that the contracted work will be completed as agreed upon. They contribute to the overall risk management strategy in commercial / residential construction and other industries where project performance is critical.

Table: Key characteristics of performance bonds in the context of investment projects

Characteristics	Description
Purpose	The primary purpose is to provide assurance to the project owner that the contractor will complete the project according to the terms and conditions of the contract.
Parties involved	Principal: The party (the contractor or project developer) that purchases the bond and commits to fulfilling the contractual obligations. Obligee: The party (the owner or investor) who receives the bond and is entitled to compensation if the principal fails to meet the terms.
Issuer	Surety company: A third-party financial institution or insurance company that issues the performance bond, providing a guarantee to the obligee that the principal will fulfill its contractual obligations.
Coverage	If the principal fails to perform as per the contract, the surety company is obligated to compensate the obligee for financial losses, up to the limit specified in the specific type of bond.
Contractual terms	The terms and conditions of the performance bond are typically outlined in the construction contract. These may include completion deadlines, quality standards, and other project-specific requirements.
Cost	The principal pays a premium to the surety company for issuing the bond. This is usually a percentage of the bond amount and is based on different factors such as the project's size and the contractor's financial health.
Limitations	There is a maximum amount that the surety company is obligated to pay in the event of the principal's default. It is essential for the bond amount to adequately cover potential losses associated with project non-completion.
Duration	The performance bond is typically in force for the duration of the project or a specific phase of the project. It may be released or replaced once the contractor has fulfilled their obligations.
Claims process	If the obligee believes that the principal is not meeting obligations, they can initiate a claim against the performance bond. The surety company then investigates the claim before deciding on compensation.

Payment bonds

A payment bond is a type of surety bond that is often used in the construction industry to guarantee that a contractor will make payments to subcontractors, laborers, and suppliers for work performed and materials supplied.

In essence, it serves as a financial guarantee that ensures the financial obligations related to the investment project are met.

Payment bonds provide protection to those working on a large construction project, assuring them that they will be compensated for their services and materials, even if the contractor defaults on payment. These bonds are typically required on public construction projects to provide a level of security and financial assurance throughout the project's lifecycle. Like performance bonds, they contribute to the overall risk management strategy and security in the construction industry.

Table: General characteristics of payment bonds in the context of investment projects

Characteristics	Description
Purpose	A payment bond is designed to ensure that subcontractors and suppliers associated with a construction project are paid for their work and materials.
Parties involved	Principal: The party that is responsible for purchasing the payment bond (usually the contractor or project developer). Obligee: The beneficiary of the bond (often the project owner) who ensures that subcontractors and suppliers receive payment.
Issuer	Similar to the above mentioned performance bonds, a third-party company issues the payment bond to guarantee that the principal fulfills its payment obligations.
Coverage	If the principal fails to pay subcontractors, laborers, or suppliers as per the contract, the surety company steps in to provide compensation.
Contractual terms	The terms of the payment bond are typically outlined in the construction contract, specifying the payment obligations and the parties involved.
Cost	The principal pays a premium to the company for issuing the payment bond. The premium is often a percentage of the total bond amount.
Limitations	There is also a maximum amount that the surety company is obligated to pay for valid claims. This limit is established to cover potential project losses related to non-payment issues.
Duration	Payment bonds are usually in force for the duration of the project or a specific phase (bond period). They may be released or replaced upon successful completion and payment.
Claims process	If subcontractors or suppliers related to the project do not receive payment, they can file a claim against the payment bond. The surety company investigates the claim before determining compensation.

As we can see, this type of financial guarantee should be considered in the relationship with performance bonds. Payment bonds are often issued in conjunction with performance bonds.

Together, they provide comprehensive protection for both project completion and payment.

Bid bonds

A bid bond is another type of surety bond often provided by a contractor or bidder as part of a bid submission for a construction project or other competitive procurement processes.

The purpose of a bid bond is to guarantee that the bidder, if selected as the winning contractor, will enter into a contract and fulfill the terms of the bid, including providing performance and payment bonds.

If the winning bidder fails to do so, the bid bond serves as a form of financial security for the project owner, who can make a claim against the bond to recover costs or losses incurred due to the bidder's default. Bid bonds are commonly used in public and private construction projects to ensure the integrity of the bidding process and protect project owners from the risk of non-performance by the selected contractor.

Table: Main characteristics of bid bonds in the context of investment projects

Characteristics	Description
Purpose	The main purpose is a bidder commitment. A bid bond is a financial guarantee that ensures a contractor's commitment to a bid and the subsequent performance and payment bonds if they are awarded the contract.
Parties involved	Principal: The bidder or contractor providing the bid bond as a financial guarantee of their commitment. Obligee: The party that requires the bid bond (usually the project owner or government entity) to secure the bidding process.
Issuer	A third-party surety company issues the bid bond to guarantee that the bidder will honor their bid and enter into a contract if awarded.
Coverage	The bid bond provides compensation to the owner if the winning bidder refuses the project after being awarded or fails to enter into a contract.
Contractual terms	The bid bond is submitted with the contractor's bid and becomes part of the bidding process, outlining the bidder's commitment to the project.
Cost	The contractor pays a premium to the surety company for issuing the bid bond. This cost is typically a small percentage of the bid amount.
Limitations	The bid bond is generally a percentage of the bid amount and serves as a guarantee that the bidder has the financial capacity to undertake project.
Duration	The bid bond is valid for a specific period, often until the project owner makes a decision on the bid or a specified time after the bid opening.
Claims process	If the winning bidder refuses the project or fails to enter into a contract, the investment project owner can make a claim against the bid bond to recover the difference between the winning bid and the next highest bid.

Bid bonds are often associated with performance bonds and payment bonds.

If the bidder is awarded the contract, the bid bond is replaced by other bonds, providing a seamless transition.

Advance payment guarantee

An advance payment guarantee (APG) is a type of guarantee provided by a contractor or supplier to a project owner or client.

The purpose is to secure an advance payment made by the project owner to the contractor before the commencement of work. Advance payments are typically made to help the contractor with initial project expenses, mobilization, and other upfront costs.

Table: Main characteristics of APG in the context of investment projects

Characteristics	Description
Purpose	An advance payment guarantee assures the project owner that the funds provided as an advance will be repaid appropriately by the contractor.
Parties involved	Principal: The contractor or supplier receiving the advance payment. Obligee: The project owner or client who requests the guarantee.
Issuer	Similar to other types of guarantees, a third-party entity (surety company or bank) issues the APG, providing assurance to the project owner.
Coverage	If the contractor fails to fulfill its contractual obligations or defaults, the guarantee ensures repayment of the advanced funds to the project owner.
Contractual terms	The terms and conditions of the advance payment guarantee are specified in the contract between the project owner and the contractor, outlining the circumstances under which the guarantee is triggered.
Cost	The contractor typically pays a fee to the surety company or bank for issuing the guarantee. This fee is often a percentage of the advance amount.
Limitations	The guarantee is usually limited to the specific amount of the advance payment, ensuring that the project owner is covered for the funds provided.
Duration	The guarantee is active during the period in which the advance payment is to be utilized, and it may expire once the project reaches a certain milestone or upon completion.
Claims process	If the contractor defaults on the contract or fails to meet the agreed-upon conditions, the owner of the investment project can make a claim against the advance payment guarantee to recover the advanced funds.

Advance payment guarantees provide a level of financial security for project owners, giving them confidence that the funds provided as an advance will be used appropriately and that there is recourse in case of non-compliance by the contractor.

These guarantees are common in various industries, including construction, where upfront capital is often required to initiate projects.

Retention guarantees

A retention guarantee is another type of guarantee that ensures the release of retention money held by a project owner during the construction or service contract period.

Retention money is a portion of the contract sum that is withheld by the project owner as security for the contractor's proper performance. The purpose of a retention guarantee is to provide assurance that the contractor will fulfill all post-completion obligations, and if not, the retained funds can be compensated.

Table: General characteristics of retention guarantees in the context of investment projects

Characteristics	Description
Purpose	The guarantee assures the project owner that the contractor will meet all post-completion obligations, allowing for the release of the retained funds.
Parties involved	Principal: The contractor responsible for fulfilling its contractual obligations and obtaining the release of retention funds. Obligee: The owner of the investment project or client holding the retention money until the completion of the contract.
Issuer	Surety company or reliable commercial bank issues the retention guarantee to secure the release of retention money.
Coverage	If the contractor fails to fulfill post-completion obligations, the guarantee ensures compensation to the project owner from the retained funds.
Contractual terms	The terms of the retention guarantee are outlined in the construction contract, specifying the conditions for the release of retention money.
Cost	The contractor pays a fee to the surety company or bank for issuing the retention guarantee. The fee is often a percentage of the retained amount.
Limitations	The guarantee is limited to the specific amount of retention money (usually percentage) being held, providing assurance for the release of those funds.
Duration	The retention guarantee is in effect during the period when retention money is held. It may expire upon the fulfillment of post-completion obligations or another specified milestone.
Claims process	If the contractor fails to meet post-completion obligations, the project owner can make a claim against the retention guarantee to access compensation from the retained funds.

Retention guarantees are common in construction contracts and other projects where a portion of the contract sum is withheld to ensure the proper completion and performance of the contract.

They provide a mechanism for project owners to safeguard against potential defects or issues that may arise after the completion of the project.

Completion guarantees

A completion guarantee is an instrument that provides assurance to stakeholders, typically investors or lenders, that a project will be completed according to specified terms and conditions.

This type of guarantee is often used in the entertainment industry, real estate development, and various other projects where the successful completion of a venture is crucial.

Table: Completion guarantees in the context of investment projects

Characteristics	Description
Purpose	The primary purpose is to assure investors, lenders, or other stakeholders that the project will be completed as outlined in the project agreement.
Parties involved	Principal: The entity responsible for completing the project (including film production company, real estate developer). Obligee: Investors, lenders, or other stakeholders who require assurance of investment project completion.
Issuer	Surety company or financial institution issues the completion guarantee to provide a financial commitment to the project's successful conclusion.
Coverage	If the principal fails to complete the project according to the agreed-upon terms, the completion guarantee ensures compensation to the obligee.
Contractual terms	Terms and conditions are outlined in the project agreement, specifying milestones, deadlines, and other requirements for project completion.
Cost	The principal pays a fee to the financial institution for issuing the completion guarantee (the fee is often a percentage of the project cost).
Limitations	The guarantee is set to cover a specific amount related to the costs of completing the investment project successfully.
Duration	The completion guarantee is in effect for the duration of the project, providing ongoing assurance until successful completion.
Claims process	If the project is not completed as agreed, the obligee can initiate a claim against the completion guarantee to seek financial compensation.

Industry-specific applications of completion guarantees include the following:

• Film industry and entertainment: Completion guarantees are common in the film industry, assuring investors that a movie will be completed on time and within budget.

• Commercial and residential real estate development: Developers may provide completion guarantees to secure funding for construction projects.

Completion guarantees play a vital role in managing the risks associated with investment project development, assuring stakeholders that their investments are protected even if the project faces challenges. These guarantees enhance trust between project principals and investors or lenders, contributing to the successful execution of various ventures.

Environmental guarantees

Financial guarantees for environmental obligations are instruments that provide assurance and financial security for the fulfillment of environmental responsibilities and commitments associated with specific projects or activities.

These guarantees are usually required by regulatory authorities or project owners to ensure that funds are available for environmental protection and remediation in case of adverse environmental impacts.

Table: Environmental guarantees in the context of investment projects

Characteristics	Description
Purpose	The primary purpose is to ensure that companies engaged in investment projects with potential environmental impacts have the financial means to address and rectify any harm caused to the environment.
Parties involved	Principal: The entity undertaking the investment project or activity with potential environmental consequences. Obligee: Regulatory authorities, project owners, or environmental agencies requiring the guarantee to mitigate environmental risks.
Issuer	A third-party entity (surety company or reliable financial institution) issues the financial guarantee for environmental obligations.
Coverage	If environmental damage occurs during or after the project, the financial guarantee ensures that funds are available to cover the costs of environmental cleanup, restoration, or remediation.
Contractual terms	The terms of the financial guarantee are typically outlined in environmental permits, regulations, or contracts, specifying the nature and extent of the environmental obligations.
Cost	The entity responsible for the project pays a fee to the surety company or financial institution for issuing the financial guarantee. The fee is often based on the perceived environmental risks associated with the project.
Limitations	The financial guarantee is set to cover a specific amount, ensuring that sufficient funds are available for environmental mitigation and restoration.
Duration	The financial guarantee is generally in force throughout the project's lifecycle and may extend beyond project completion to cover any latent environmental issues that may arise.
Claims process	If environmental damage occurs, the regulatory authorities or obligees can initiate a claim against the financial guarantee to access funds for the necessary environmental remediation efforts.

Types of environmental obligations:

• Contaminated site cleanup: Guaranteeing funds for the remediation of contaminated sites.

• Habitat restoration: Ensuring financial resources for the restoration of affected ecosystems.

• Waste management: Providing assurance for proper disposal and management of waste generated by the investment project and its infrastructure.

These financial guarantees play a crucial role in holding entities accountable for the environmental impact of their activities and contribute to sustainable and responsible business practices.

They help improve ecosystems, protect public health, and ensure that environmental liabilities are appropriately addressed and funded.