A performance bond is a guarantee, usually issued by an insurer or bank acting as surety, that protects the Client if a contractor fails to carry out the contract, most often because of insolvency or abandonment of the site. If the contractor defaults, the bond compensates the client or funds the cost of bringing in a replacement contractor, up to the bond's value. On UK projects, performance bonds are typically set at 10% of the contract value and can be either "on demand", paid out on request, or "conditional", requiring the client to show that the contractor failed to perform and that a loss resulted.
Worked example
A Main Contractor signs a £4m contract for a new warehouse and the client requires a performance bond. The bond is set at 10% of the contract value, £400,000, issued by a bank on the contractor's behalf. Six months in, the contractor becomes insolvent with the shell only half built. The client claims against the bond, using the £400,000 to help fund a new contractor finishing the works, rather than absorbing that cost alone. The bond usually stays in place until practical completion, and sometimes until the end of the defects liability period if the contract calls for it, so the client's protection does not disappear the moment the building is handed over.
Performance bonds in the cost report
Like a Bid Bond, the performance bond itself does not usually sit as a line item in the main contractor's cost report, since it is a contractual guarantee rather than a cost the project pays out. Its premium, typically 1 to 3% a year of the bond value, does show up as an overhead cost on the contractor's books, and is usually priced into the original tender. For the client, the bond is more of a contingency against contractor default than a budget line.
Related terms
Bid Bond, Bonding Capacity, Defect Liability Period.
FAQs
How is a performance bond different from a payment bond?
A performance bond protects the client against the contractor failing to complete the works. A payment bond protects subcontractors and suppliers by guaranteeing they get paid for work and materials already supplied.
Who pays for a performance bond?
The contractor arranges and pays for the bond, but the cost is typically built into the tender price, so the client effectively pays for it through the contract sum.