Financial security issues related to terminations

Financial security issues related to terminations cover what happens to a contractor's financial security when a government contract ends early. The security may be a security deposit, an irrevocable standby letter of credit, a performance bond or a payment bond. The correct action depends on the type of security and on whether the termination came about through the contractor's fault.

Financial security protects the Crown against contractor default, non-performance, non-payment of labour or materials, and the cost of completing work. The Public Services and Procurement Canada (PSPC) buyer guidance on termination of contracts with financial security sets out the steps buyers follow for each type.

Security deposits on terminated contracts

A security deposit can consist of government-guaranteed bonds, bills of exchange or irrevocable standby letters of credit. PSPC tells buyers not to terminate a contract secured by a security deposit without first getting advice from legal services.

If the contract ends through no fault of the contractor, the security deposit must be returned. For a bill of exchange, the PSPC Finance Branch is instructed to requisition a cheque for the amount plus accumulated interest. For bonds, letters of credit and other negotiable instruments, Finance Branch is asked to arrange their release.

Surety bonds, payment bonds and performance bonds

A contract secured by surety bonds must not be terminated in a way that also ends the contractual relationship with the bonding company. Preserving that relationship keeps the surety's obligations available to the Crown.

• Payment bonds: when a contractor fails to perform, or a claim arrives for non-payment of labour or materials, the buyer must immediately notify the surety in writing and request corrective action.
• Performance bonds: if the buyer intends to direct the surety to complete the work, the buyer must verify the surety's compliance with the Ineligibility and Suspension Policy clauses. A proposed completing contractor must also be checked.

The federal directive on financial security

The Treasury Board's Directive on the Management of Procurement requires contracting authorities to consider whether financial security is appropriate and proportionate to procurement risks. Those risks include a contractor's failure or inability to perform. The directive also addresses redeeming financial security held by the Crown when a bidder or contractor defaults.

The CanadaBuys termination guidance applies to PSPC-administered federal contracts. It is the clearest statement of the Canadian procedure.

Related treatment in NATO procurement

NATO procurement uses similar concepts under its own rules. The NATO Procurement Manual states that securities must be liquidated at the time and in the manner specified in the contract. Performance bonds, holdbacks and guarantees are returned once the supplier has fulfilled its obligations.

NATO contract conditions also separate termination for convenience from termination for default. Under the NCIA general terms and conditions, a performance guarantee may be forfeited when the purchaser terminates for default, depending on the circumstances. These NATO rules are separate from the PSPC procedure.

What it means for a supplier bidding on Canadian public contracts

Suppliers should know exactly which instrument secures their contract and read the termination provisions alongside it. The sources point to these practical obligations:

• Comply with the security instrument and the contract's termination provisions.
• Understand whether the security is a deposit, letter of credit, performance bond or payment bond.
• Provide the information needed for release, replacement or enforcement of the security.
• Cooperate with the surety and the contracting authority after a default or a non-payment claim.
• Make sure any proposed completing contractor meets the applicable integrity and ineligibility requirements.

A termination through no fault of the contractor means the security deposit comes back. A termination for default puts the security at issue.