Unbonded Contracts: A Tax-Payer High-Wire Walk Without Safety-Net

The Dangers of Unbonded Contracts

Malawi is one of the few countries in the world that does not require contractors to post performance guarantee bonds on government contracts. I once asked the Chief Contracts Officer in Malawi why there is no requirement for contractors engaged in farm-subsidy contracts to post performance guarantee bonds to better protect taxpayers against the consequences of possible breach of the contract. My query arose from the understanding that this leaves taxpayers at risk of financial loss if a contractor defaults on their obligations.

I also suggested that this would shift to the bonding industry the burden of performing a full 360° prudent review of a prospective contractor that ascertains the contractor’s demonstrated commitment to financial responsibility and ethical business practices.

The Chief Contracts Officer told me that it would add “unnecessary” costs to a program already costing taxpayers hundreds of billions of Malawi Kwacha. I countered that this is all the more reason for bonding the contracts to make it more difficult for the public to be short-changed through such contracts and public funds to disappear into private pockets.

The Chief Contracts Officer was unconvinced that contract bonding provides a quicker and more certain remedy for contract breach compared to suing the defaulting party (as long as the value of the bond is sufficient to cover the damage). He also believed that the costs related to bonding are negligible compared to the problems arising out of not bonding contracts.

The need for guaranteeing promised performance was recognized and codified by Mesopotamian farmers as early as 2750 BC and has grown into the thriving industry it is today. Even the Bible (Ecclesiasticus 29:14-19) was quick to acknowledge the prudential value of guaranteeing promised performance from someone whose honesty you are not sure of.

Guaranteeing promised performance has what is termed a “Sword of Damocles” effect, where the threat, knowledge, and certainty of bond invocation is enough to persuade the contracted party to comply or perform as promised because bond invocation carries a very real risk of unpleasant commercial consequences (damage to commercial reputation, standing, and creditworthiness which may affect ability to pre-qualify for other tenders as well as being able to obtain finance, even the risk of economic ruin). It is also enough to dissuade bonding companies from bonding contractors without capacity and, thereby, improving integrity in the contracting sector while ensuring the sector has only bondable players.

From its inception, farm-subsidy contracting in Malawi has been characterized by incidents of open sesame willful theft by contracted parties or their agents (incidents repeated a thousand times across the length and breadth of the country each farming season). Such incidents would never have seen the light of day with the bondholder enjoying and exercising the unrestricted right to invoke a performance bond. Tenderers recognize the impossibility of delivering on the contract nonetheless undertake the contract aware they will not suffer the commercial consequences when and if they fail to deliver as promised.

Unlike farm-subsidy contracts, other government contracts in Malawi are generally bonded (require the provision of bid bond, advance payment guarantee, performance guarantee, etc.) nonetheless contractors undertake the contract aware that the government does not invoke bonds posted on the contract in case of default. Instead, the government leaves taxpayers to shoulder the commercial consequences of contract breach.

For example, the Roads Authority will “close” or “terminate” the contract and proceed to blacklist the contractor for the next 12 months if adjudged to have materially breached the contract but will not execute the performance bond the contractor posted to compel compensation for breach or finance contract completion. The Roads Authority uses bond requirements as pre-qualifying requirements and not as risk transfer instruments for protecting taxpayers from the default risk.

What is clear is that taxpayers are not left to shoulder the commercial consequences of a default with a bonded contract. It is extremely imprudent that almost five thousand years after Mesopotamian farmers recognized the value of guaranteeing contracts, any responsible government would be executing contracts without foolproof supports and protections for the contractual obligations it enters into with entities it hardly knows.

Contribution by: Maxwell L. Chisala is a social commentator who hails from Likoma Island in Malawi. He commentates on critical issues affecting the legal, social, and economic development trajectory of Malawi.