What are Performance Bonds and Who are They For?

If you’re a contractor or a builder, then a project owner or developer may ask you to acquire a performance bond before they tender any work to you. But, what are performance bonds and who do they protect?

Put simply, performance bonds offer financial protection. They provide project owners or developers with essential financial protection should a contractor be unable to complete a project due to insolvency or breach of contract.

In this guide, we’ll dive into detail and reveal everything you need to know about performance bonds, including what they are, who they help and how much they cost.

What are Performance Bonds?

A performance bond is a form of financial guarantee. It protects one party (usually a property owner) against another party’s failure to complete work they’ve been contracted to deliver (such as a builder or contractor).

Performance bonds are usually issued by either a bank or an insurance company and they ensure that a contractor fulfils their contractual obligations. As a result, they’re most commonly used in the construction industry and are sometimes referred to as ‘construction performance bonds’.

Performance bonds play a crucial role in large-scale projects, as they protect the project owner from a financial loss if the contractor either defaults, becomes insolvent during the build or fails to complete the work. As such, they are usually used to guarantee the completion of a project.

It’s important to state here that there’s no legal obligation for a contractor or a construction company to take out a performance bond. However, many project owners will ask for one before they sign off the work. As a result, they are usually very important if you’re looking to win new clients.

How Do Performance Bonds Work?

A performance bond guarantees that the terms of a contract will be honoured. For example, if one party to a contract cannot complete their obligations, the bond is paid out to the other party to compensate for their damages or costs.

Performance bonds involve three parties:

• The contractor or service provider who is responsible for carrying out the work required (The Principal)

• The project owner or developer who requires the work (The Obligee)

• The bank or insurance company that issues the bond (The Surety)

If a performance bond has been issued and the contractor fails to deliver the project according to the agreed contractual terms, the performance bond can be 'called'.

In this instance, The Surety will either allow The Principal to hire a replacement contractor to finish the job to the agreed standard, or they will compensate the project owner for the financial damages incurred, typically up to a stated maximum value.

What Types of Performance Bond Are Available?

Generally speaking, two kinds of performance bonds are available. These include:

Conditional (Default) Bonds: These performance bonds require the project owner to provide demonstrable proof that the contractor has breached the contract before The Surety pays out. Here in the UK, this form of performance bond is considered to be the industry standard.

On-Demand Bonds: More common in international projects, these performance bonds allow The Obligee to claim the money from The Surety without having to satisfy preconditions.

How Much Do Performance Bonds Cost?

The amount a performance bond will cost depends on several factors, including which performance bond provider you choose, the overall financial strength of your business, the complexity of the project and market conditions at the time.

Generally, a contractor will usually pay an upfront premium to The Surety to secure the bond.

The bond amount usually covers about 10% of the value of the overall contract value. That said though, this can vary depending on the risks associated with the project. Using your bank generally costs less than using an insurer. However, a bank deducts the value of the bond from your facilities, thus reducing your available credit. One major advantage of using an insurer is to free up bank facility.

Why are Performance Bonds So Important?

In industries such as construction, performance bonds are essential for mitigating risk for multiple parties. For example, they provide peace of mind for developers and they allow contractors to demonstrate financial stability and win more work. In many instances, a performance bond can be particularly helpful for contractors who are applying for either public sector contracts or larger tenders.

How Do I Get a Performance Bond?

If you’re a contractor or a builder and you’re in need of a performance bond to fulfill the terms of a contract, then speak to us.

We have decades of experience when it comes to arranging performance bonds and can broker an option that suits you and your project. So, if you’re in need of a performance bond, call us on 0114 345 10 20 or email info@eximiabroking.co.uk.

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