Performance Bonds Explained in 5 minutes
Updated: Feb 22, 2022
What is a Performance Bond?
According to the dictionary, a performance bond is a bond issued by a bank or other financial institution, guaranteeing the fulfilment of a particular contract.
According to those working within the Surety (Bond) market, a performance bond is a tripartite agreement whereby a Surety (the Guarantor) guarantees the contractual obligations of a principal (the Contactor) to the beneficiary (the Employer) in the event that the principal breaches the contract or becomes insolvent.
Essentially the Guarantor promises to pay the Employer damages up to a fixed percentage of the contract sum. Subject to this limitation, the liability of the Guarantor under the Performance bond shall be co-extensive with the liability of the Contractor under the Contract.
When might a Performance Bond be required?
The obligation for a principal or contractor to provide a performance bond under a contract is subject to the discretion of a beneficiary or employer. A beneficiary might always include the provision for a performance bond within their standard contract template but this requirement can be waived or enforced by the beneficiary depending on the circumstances.
Typically a principal would need to provide a beneficiary with a performance bond when entering a contract with a value in excess of £1,000,000. but it has been known for a beneficiary to insist that a principal provide a performance bond to cover a contract of a lesser value. Equally, it is quite common for the requirement to be waived on schemes well in excess of this value.
What is the value of a Performance Bond and how is this decided?
The bond value is typically 10% of the contract value in the United Kingdom but can be as high as 25% in the Republic of Ireland. The traditional 10% value is generally accepted as the upper limit of the damages that a beneficiary might suffer in the event of the principal breaching the contract or becoming insolvent. Whilst the bond value remains fixed, the actual liability or damages payable under a performance bond fluctuate throughout a contract, as valuations are paid, works completed and retentions deducted.
How long does a Performance Bond last?
Performance bonds typically expire upon the date of issue of the Certificate of Practical Completion or "PC" as issued under the contract to which the performance bond relates. The expiry event included within a particular performance bond is usually agreed before a contract is signed. We therefore recommend that all principals qualify during the tender stage that if a performance bond is required then it should expire at PC.
If a beneficiary requires a bond beyond PC then it is recommended that the expiry provision is linked to PC rather than tied to the date of issue of the Certificate of Making Good of Defects.
It can take up to 12 months or longer for a defects certificate to be issued after the PC Certificate. At this stage it is highly unlikely that in the event of the failure of the principal that the damages due to the beneficiary will be 10% of the contract value therefore this is an over provision of security which only benefits the Surety. We often find that the team responsible for the issue of the defects certificate has moved on and therefore there isn't anyone willing to sign off on the certificate which leads to additional premiums being payable and the unnecessary utilisation of capacity.
How does a Performance Bond benefit a
Given the strict underwriting criteria of all rated surety bond providers in the UK, the ability to provide performance bonds benefits contractors. By demonstrating to their potential Employer that they have provided evidence of strong credit worthiness to a stringent financial service provider, the contractor might be boosted up the tender list. The provision of this security can also lead to a reduction in other security that a contractor might ordinarily provide under a contract such as; parent company guarantees, personal guarantees, increased retention sums and delayed payment provisions.
How might a Contractor avoid providing a Performance Bond?
A contractor might be able to remove the obligation to provide a performance bond under a contract by reversing some of the benefits mentioned above. Such as; providing a parent company guarantee, providing personal guarantees, increasing retention sums and extending payment terms. Whilst these are all negative outcomes contractually, performance bonds from rated entities aren't available to all or the contractor might wish to maintain performance bond facility capacity for other contracts.
Contractors are also able to negotiate away the obligation to provide a performance bond by demonstrating their credit worthiness or by building up a strong track record with a particular beneficiary. It is worth noting, that the contractor's obligation to provide a performance bond is always subject to the sole discretion of the beneficiary.
The beneficiary will usually pay for the provision of a performance bond under the contract therefore another way to remove the requirement is for the principal to offer a cost saving if the beneficiary removes the bond requirement.
What does a Performance Bond look like?
The industry standard performance bond is universally accepted in the construction industry and can be found on our blog or we will happily email you a copy on request if you want to get in touch. Having a standard industry wording can be very advantageous, as it can save the contractor and the customer legal fees relating to the drafting and approval of an acceptable bond wording. The industry standard word is also much cheaper to obtain than an on demand or adjudication style wording.
How much does a Performance Bond cost?
The premium rate charged by a surety for a performance bond will depend on the financial strength of the contractor and the nature of the bond wording. The premium rate payable can vary between 0.4% of the bond value to 10% of the bond value and some surety providers will ask for additional security from the contractor if they deem that the risk demands it.
Who pays for a Performance Bond?
The requirement for a performance bond under a contract is usually paid for by the beneficiary under the terms of the contract. The principal however will usually pay for the performance bond during the first month of the contract and then claim the premium back from the beneficiary within the first valuation.
Can PS Surety help?
PS Surety is a dedicated surety bond brokerage and we would be delighted to assist any contractor with placing performance bonds. We are fully regulated by the FCA and we guarantee that we provide our clients with:
The best possible terms available in the market
An honest, open and joint approach to our client's Surety needs
Detailed client dashboard providing information on every bond ever placed by the client with PSS
Communication when bonds become overdue in order to help our clients to avoid or reduce additional premium charges
A single touch point within our organisation for wording reviews, quotes and queries
That Sounds expensive!
Our service is completely free to contractors. We are paid a commission by the surety providers on each bond that we place with them on behalf of our clients, the details of which are fully disclosed in our client dashboard. The surety providers are happy to pay our commission because we specialise in bringing them business which fits their ever changing underwriting criteria. We also deal with frequent queries, wording issues, bond drafting and general administration. The price that you pay PS Surety for a bond is the same price that you would pay any Surety if going direct.
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