When are performance bonds required?
What are performance bonds?
Performance bonds are a type of financial guarantee. They are issued by a guarantor (a bank or insurer) on behalf of a builder or contractor, to the other party in a project contract (i.e. the client).
Under the bond, a certain amount of money will be paid to the client if the project cannot be completed by the builder for some reason.
The money paid out by the guarantor will allow the client to finish the work the builder was contracted to complete.
Are performance bonds a legal requirement?
While they are not a legal requirement, they are often a contractual requirement. If you do not have an appropriate bond, you will not win the contract.
It is common for large commercial clients to request that a performance bond is in place before a project starts. It is becoming increasingly common among smaller clients too.
Why might a client insist on a performance bond?
Construction performance bonds are often listed as a requirement in project tender documents, especially among local and regional authority clients. A bond provides the client with proof of the financial strength and viability of your business.
A client is within their rights to want reassurance that you can complete a project successfully, on time and to budget.
A performance bond helps mitigate potential risks to the project’s progress, as it will help cover the client’s costs should something go seriously wrong on your side of the contract.
For example, you may experience a materials or labour shortage which affects the project’s timescales, be unable to meet the project specification, or experience cashflow and solvency problems which impact on productivity.
Do I need performance bonds for my own financial protection?
Performance bonds do not protect you or pay your losses if you cannot meet your contractual obligations. They are designed to pay a specified amount to the client in the event of a breach of contract.
Performance bonds are not the same as an insurance policy; you may also require separate business insurance.