What are performance bonds? | A quick, no-nonsense guide

If you are a principal contractor it is likely, given the current economic climate, that you will be asked for a performance bond at some point from a Beneficiary or Housing Association. 

We recognise performance bond requirements are becoming a lot more common, with many experiencing a performance bond for the first time, therefore, it might be the case that you don’t already know what a performance bond is. So, in this article we’ll explain:

• What a performance bond is
• The different types of performance bonds you will be asked for
• How to secure one quickly and cheaply

We also want to be upfront and say, yes we are a company that helps to secure performance bonds. (You can view our main performance bonds service page here.) But in this article, we are going to try to look at them in an objective/impartial way, so that you can make the most informed decisions based on your requirements. 

Performance bonds are financial instruments designed to ensure that parties involved in a contract, often in the construction sector, fulfil their obligations as specified in the agreement. These bonds act as a guarantee that a project or job will be completed by the terms and conditions outlined in the contract. For this reason, they are also sometimes referred to as contract guarantee bonds.

Performance bonds offer protection to the project owner or obligee, typically by providing financial compensation in case the contractor or principal fails to meet their contractual obligations. For example, a contractor working with a housing association on a development for a large number of plots will very likely need to offer the housing association a performance bond to guarantee security and that the work will be completed. 

Similar to performance bonds are advanced payment bonds. A payment bond ensures that, upon completion of a project, a party will pay all parties involved, including suppliers, labourers, and subcontractors. Click here to learn more about the advanced payment bonds we provide.

Performance bonds are also sometimes utilised in large fit-out and renovation projects, renewable energy projects, and non-construction related projects.

The Association of British Insurers (ABI) provides specific and standardised template wording for performance bonds. An ABI performance bond is therefore simply a bond that uses this standard wording. The most common performance bonds we deal with are in ABI standard wording, and many beneficiary/housing associations request them to be worded in this way. 

However, if your employer requires a different type of wording, we can also procure other, on-standard, bond formats.

An on-demand bond is another type of performance bond. What makes on-demand bonds different is they do not require the employer (typically the project owner or client) to provide evidence of a breach of contract or to fulfil specific conditions to call upon the performance bond. 

With on-demand performance bonds, the beneficiary can make a claim and receive payment from the bondsman immediately upon first written demand for payment. The beneficiary does not need to show evidence of non-performance or contractual violation. In essence, it is a more straightforward and immediate form of financial guarantee for the beneficiary.

On-demand bonds are also sometimes referred to as ‘unconditional bonds’ or ‘demand guarantees’. 

Conditional bonds are essentially the opposite of on-demand bonds. The employer requires evidence of breach of contract and the payment terms to the surety providers are often less demanding.

The conditions to which a performance bond becomes enforceable are detailed within both the bond wording and contract. This may include the following scenarios:

• The contractor’s failure to complete the project within the agreed-upon timeframe.
• Failure to meet specific quality or performance standards outlined in the contract.
• The contractor’s financial default or inability to pay subcontractors and suppliers.
• Other specific conditions that are stipulated in the contract.

We have a 100% track record of helping our clients secure performance bonds, regardless of their financial status — and we are also proud to say we have the largest network of underwriters able to supply bonds, and so, therefore, will be able to offer you the most favourable terms. 

Alternative options to a performance bond include:

• Increased retention — Your employer can hold back more retention until key milestones are achieved.
• You could negotiate out of the need for a performance bond — Though this would offer the employer less financial protection (more on this below).

Many government contracts and large-scale projects also require performance bonds as part of the bidding and contracting process. 

If you are a beneficiary, you may need a performance bond in place as a form of risk management or risk mitigation. This means that, if the contractor fails to fulfil their obligations, the bond will cover the work that needs to be completed. This usually means covering the costs of hiring a replacement contractor to complete the project without any additional financial burdens. 

A performance bond may also cover the employer against the insolvency of the contractor, should this happen.

Securing a performance bond displays financial strength and credibility, allowing you to gain an edge over the competition and secure a deal on a project. After all, if you’re offering a performance bond and the others are not, you’re essentially telling any beneficiaries that they can rely on you for extra security and protection.

After all, if you have secured a performance bond in principle during the tendering process and other contractors have not, the employer may see you as a more favourable contractor.

The advantages for the employer are risk mitigation and financial protection. 

Whereas for the contractor, the benefits are that they can help secure contracts, when they aren’t a contractual compliance, and they are also a great way to build credibility and trust. 

Some of the potential disadvantages include the following:

• Performance bonds cost money — for employers there are bond fees to be paid. For example, this includes the surety bond provider fees and any admin fees of the broker. This initial cost is typically only a small percentage of the bond value.
• They can delay projects — if the surety provider requires more financials this can slow things down, which we recognise can be a significant problem when working towards deadlines. However, at CG Bonds, we appreciate and understand these time constraints and therefore will do everything we can to expedite the bond process.

We hope this article has answered your question. Performance bonds are often necessary and sometimes they aren’t. 

If you’ve been asked ‘what is a performance bond?’ or asked to get a performance bond and are struggling due to hardened market conditions, please give us a call, send an email, or complete our application form. We guarantee you’ll secure a performance bond with us, at the lowest price possible. 

View the other construction bonds that we offer here. 

Fill in our application form — it’s quick & easy, and we’ll help if you get stuck