A performance bond is a issued by a company or a bank to guarantee satisfactory completion of a project by a contractor to a developer/employer.

Following a successful tender process, it may be a contractual obligation of a contractor to purchase a performance bond. By doing so they provide security throughout the contractual period to all relevant parties involved. If the contractor was then to default under the terms set out in the contract, the developer/employer would receive monetary compensation up to the amount of the bond in question.

Within the UK construction market the value of a performance bond will be approximately 10% of the contract value, however, this can of course vary and is not a fixed percentage.

It is imperative that it is understood from the beginning the content of the performance bond and the implications it can have. It is especially important to be fully aware of the potential financial outcomes in the event that the bond is to be relied on.

There are two main types of performance bonds which are set out in more detail as follows:

Conditional Bonds On-Demand Bonds Where to purchase and why Advance Payment

A conditional bond is the type of bond that is most commonly used within the construction industry in the UK. This type of bond provides for an element of control between the respective parties involved i.e. the insurer and the developer/employer.

In this case, the burden of proof lies with the developer/employer and they can then make a request for payment by providing substantiating evidence of the loss that has been suffered. It may be the case that the insurer involved decides to begin litigation proceedings prior to making any payment, however, in practice this situation would be considered unlikely; most credible insurers wish for this product to be seen as a benefit to employers, giving them the comfort that a contribution will be made to their financial loss stemming from the failure of the contractor.

Provided all of the documentary evidence proves the claim sits under the bond wording, insurers generally pay; settlement generally occurs after the works have been completed by the replacement contractor and all costs have been met, this allowing for the claim to be substantiated in full.

On very rare occasions within the UK construction sector, on-demand bonds are requested. This type of bond results in an automatic cash payment if the contractor failed to complete a project set out under the terms of the contract.  In most instances these will be written by a bank.

Banks 

For: In the majority of instances a bank will hold 100% cash collateral against the bond as security for the entire contract period. Whilst this may first appear to be a negative, if the purchaser of the bond has significant/relevant cash reserves then there is a strong positive for purchasing from the bank. If this option is selected, the bank will be responsible for paying any interest on the cash amount. Over the contract period this interest earned will in most cases pay for the bond itself.

Against: This option can seriously effect the purchaser’s cash flow for the entire contract period. Due to the current economic climate it is much more difficult to arrange an overdraft facility than it has been in previous times.   Even if an overdraft is offered, it can have very restrictive terms i.e. personal guarantee(s) requirements. It is important to bear in mind such cash flow implications when purchasing from the bank.

Surety Companies

Purchasing the bond from surety companies frees up cash flow in comparison to the option above. The cost of the bond is paid for as a standalone payment and therefore will not have an effect on company’s banking and finance facilities. It is extremely important to be aware of all terms and conditions as in the event that a payout is made, a surety company will seek to recover from the relevant company/individuals.

Alternative Bond Types used within this sector:

Retention Bonds:

A retention bond is generally issued at the request of and in the favour of the principal contractor/employer.

The principal contractor may request to hold in the region of 3% – 5% of the contract value for a period of circa 12 months. Should the principal contractor request to hold such a fund from the sub-contractor this would cause damage to a sub-contractor’s cash flow. By purchasing a retention bond, the sub-contractor is able to give the principal contractor the same ‘guarantee’, without causing damage to cash flow.

When a sum of money is paid at an early stage (generally necessary for product purchase), the developer/employer may request for an advance payment guarantee. The purpose of this being the employer may recover the amount paid in advance should the contractor/sub-contractor fail to complete or adhere to their contractual obligations.

Bonds issued under English Law are generally executed as a deed.

In order for Consort Insurance to provide indicative terms, various information is required.  We perceive that the following forms below provide HCC to capture all of the applicable information in the most straightforward but detailed way.

In the event that we have not been provided with the most recent set of audited accounts, please provide a set of these along with current management accounts.

 

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