What is a performance bond ?

Sometimes referred to as a surety bond, a performance bond is a guarantee issued by an insurer, bank or surety company (guarantor) on behalf of a building contractor or sub-contractor (principal) in favour of the party employing them under a building contract (beneficiary).

If the builder or subcontractor defaults on the building contract the guarantor will cover the beneficiary’s additional costs in completing the contract up to the bond amount.

In the UK the bond amount is typically 10% of the contract value but it can be for any amount agreed between the parties. In Eire they are typically for 20-25% of the contract sum.

The performance bond can be a “conditional proof of loss” or an “on-demand wording”

Conditional proof of loss bond

In the default/insolvency of the contractor, the beneficiary has to establish the loss incurred by reference to the underlying building contract, normally the works will have to have been completed by the replacement contractor for this to be achieved which may present cash flow shortfalls for the beneficiary.

There are variations on this type of bond, sometimes referred to as a “financing bond”, where once the likely loss is established on paper; the guarantor will pay over the estimated cost in advance of the work being completed. The beneficiary then accounts back to the guarantor on completion. This type of bond wording will normally be more expensive to procure because of the cash flow disadvantage to the guarantor.

On demand bond

These bond wordings are generally offered by banks, although a few surety and insurance companies will exceptionally offer them.

If a default occurs on these types of bonds the beneficiary simply calls the bond in and the guarantor has little option but to pay over the funds irrespective of whether a loss has been proven. Unfair calling can be challenged in the courts.

Banks will normally only offer these bonds on a fully secured basis or reduce overdraft facilities by the bond amount.

How much does a performance bond cost?

The cost is usually expressed as a percentage of the bonds face value. The exact rate charged depends upon a combination of factors, length of bond period, the contractor’s financial standing/experience and the type of wording. Rates vary from between 1% and12%, higher rates apply for financing and on demand wordings. Additional security is sometimes also required by the bond underwriter.

Bank versus Surety or Insurance Co

TBank will normally want a full cash deposit equal to the bond amount before they will issue the bond, if you are fortunate to have the cash, normally it will still pay you to use a surety or insurance company as they will have lower administration fee and you still get valuable advice on the bond wording ,wheras banks seldom query onerous wordings, why would they if they are fully secured??

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