What is a performance bond?
Most, if not all construction contracts require the contractor to provide the employer with a Performance bond. The purpose of such performance bonds is to provide the Employer with an efficient and fast remedy should the Contractor default in carrying out its obligations under the construction contract.
A performance bond is issued to one party of a contract to act as a guarantee should other party fails to meet the obligations specified in the contract. Usually a performance bond is provided by an insurance company or a bank to make sure a contractor completes designated projects.
If the contractor has clearly defaulted on its obligations for example abandoning the works or refusing to complete the works for no reason, then the employer has a right to liquidate the bond.
What is the typical cost of a bond?
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”
What are the types of bonds?
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.