How do Performance Bonds Work?
Understanding Performance Bonds and how they work is important in the construction industry, whether you are a contractor or employer. Therefore, understanding how Performance Bonds work is also vital. This blog will discuss everything you need to know about how Performance Bonds work and their relevance to construction projects.
What is a Performance Bond?
A Performance Bond is a kind of Surety Bond used widely in construction and development projects. In simple terms: it’s a guarantee from a third‑party surety that the contractor will complete the work as specified in the contract. If the contractor fails, for example through insolvency, abandonment, non‑performance or substandard work, the Bond assures the project owner of financial protection.
Who Issues Performance Bonds and Who Pays for Them?
The Bond is typically issued by a bank, insurance company or surety provider. Although the contractor formally obtains the bond, the cost is usually built into the contractor’s tender or contract price, so effectively the employer often bears the cost indirectly.
Because the surety is taking on risk, obtaining a bond normally involves due diligence, including assessment of the contractor’s financial strength and track record. Using a Bond does not relieve a contractor of their obligations, it simply provides a financial back‑stop in case they default.
Key Features & Typical Structure of a Performance Bond
Bond Amount: In the UK it is common for a Performance Bond to be set at around 10% of the contract value, though this may vary depending on project risk, size or scope.
Duration / Term: The Bond typically runs from contract award through to project completion (practical completion), and may also cover any defects liability period.
Trigger Events: The Bond can be called if the contractor fails to meet contract obligations, for example, if the contractor becomes insolvent, abandons works, fails to complete, or delivers substandard work. In that event the beneficiary can claim under the bond.
Types of Bond Wording
Conditional / Default‑based Bond: A claim requires evidence of default (e.g. non‑completion, insolvency, substandard work, breach).
On‑Demand / Unconditional Bond: The employer may call the Bond (i.e. demand payment) without needing to prove a breach or loss, often used on larger or more complex or higher‑risk projects.
Stand‑alone Guarantee: Unlike contractual rights under the main building contract, the Bond is a separate instrument, so its enforceability and obligations are defined by its own wording, not by the underlying contract terms.
What Happens If the Contractor Defaults?
If the contractor becomes insolvent or fails to complete the project to the required standard or timeline, then the beneficiary can call the Bond. Under the terms of the bond, the employer issues a demand for payment. For conditional bonds, evidence of default may be required; for on‑demand bonds, the demand may suffice.
After the Bond is called, the surety (bank or insurer) makes payment up to the bond’s sum, which is commonly 10% of the contract value. The employer then uses these funds to finish or remedy the project, whether that’s by hiring a new contractor or fixing defects. This protects the employer against financial loss due to contractor failure.
The Key Benefits of Using Performance Bonds
Using a Performance Bond offers several important advantages for employers / developers / funders:
- Risk Mitigation & Financial Security: The bond serves as a financial safety net if the contractor fails.
- Improved Credibility for Contractors: Contractors who can provide a Bond demonstrate financial stability and reliability.
- Facilitates Funding / Lender Confidence: On many developments, funders or lenders may require Bonds to protect their investment.
- Project Continuity & Reduced Disruption: In the event of default, the employer has funds available immediately to complete or rectify works, reducing delays and disruption.
When Are Performance Bonds Usually Used and Why They Matter
Bonds are standard in many UK contracts, notably within contracts based on standard building‑contract forms. They are commonly requested on larger or higher‑risk projects: housing developments, social housing, public projects, major renovations, fit‑outs, or where funders require added security.
Bonds are particularly valuable in situations where retention (holding back payment) may not be feasible or sufficient, or where the employer or contractor prefers not to tie up cash or rely on retention mechanisms.
Performance Bonds and More from CG Bonds
A Performance Bond is not just a formality, it is a vital risk‑management tool that offers security, flexibility and peace of mind for employers, developers and funders. When correctly structured and administered, it provides a strong guarantee that contractual obligations will be met, or, if not, that financial protection is in place.
Understanding how Performance Bonds work: who issues them, what they cover, when and how they pay out, is essential for anybody involved in construction or development projects. At CG Bonds Surety, we guide contractors and developers through this process, aiming for a tailored, efficient and compliant bonding solution. Request a quote today for a Performance Bond.
