What is a performance bond, and should I agree to one?
A performance bond is a bank's or insurer's promise to pay your main contractor a set sum if you fail to perform your subcontract.
Updated: . By Jack Butler-Kettle, Construction Claims Consultant.
The answer
The bank or insurer, called the surety, charges you a premium for it. It will usually ask you to sign a counter-indemnity too, a promise to repay anything it pays out. So the risk stays with you, and so does the cost. Agree to a bond only once you have checked four things. First, the wording. An on-demand bond pays out when your main contractor asks, without proving you are at fault. A default bond pays only once your default and its loss are shown, so ask for one. Second, the amount, and whether it reduces once your work is complete. Third, the expiry. The bond should end on a fixed date or when your work is complete, not run on with no end date. Fourth, the cost. Get a quote from your bank or surety and put the premium in your price. A bond can also use up part of your bank facility or surety line, which limits what else you can take on. Some main contractors ask for a parent company guarantee instead, a promise from your parent company to stand behind the subcontract. What the wording of either means in law is a question for your solicitor.
Example
Illustrative example. The scenario and figures are invented.
The facts
A steel frame subcontractor is offered a £1.2m subcontract. It must give an on-demand performance bond for 10 per cent of the subcontract sum, £120,000. The bond runs until 12 months after the main contract is complete.
What happens
- The subcontractor asks for a default bond in place of an on-demand bond, so a demand needs its default shown first.
- It asks for the bond to fall to £60,000 once its frame is complete, and to end when its own work is complete.
- It gets the premium quoted by its surety and puts it in its price.
- The main contractor agrees the default wording and the reduction, and keeps the expiry as drafted.
The outcome
The subcontractor signs with the bond's cost in its price, and a demand now needs its default shown first. Once the frame is complete, £60,000 of its surety line is freed.
To have the bond checked with the rest of the subcontract, and its cost set against your price before you sign, see our Pre-Signing Contract Review service.