Many building contracts now require contractors to take out a Performance Bond. A Performance Bond is a form of security provided by a contractor to a developer and consists of an undertaking by a bank or insurance company to make a payment to the employer in circumstances where the contractor has defaulted under the contract.
There are two types of performance bond - "on demand" and "conditional".
On Demand Bonds
On demand bonds are rarely used in the UK construction industry, but they are a standard requirement in many international contracts, as well as in the petroleum and power industries within the UK. On demand bonds are usually provided by banks, and as the title suggests, the bank is required to make a payment under the bond whenever this is demanded.
Conditional Bonds
A conditional bond, by contrast, is common within the UK construction industry. Such a bond is usually issued by an insurance company, and payment is usually conditional upon the employer who makes the call proving the amount of loss which he has suffered. In practice, therefore, a conditional bond may require litigation before any payment can be obtained.
The value of a performance bond is usually expressed as a percentage of the contract price, usually between five and twenty per cent of the contract price with ten per cent by far the most common figure. A bond issued under English law is usually executed as a deed.
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Banks vs. Surety Companies
The two main suppliers of Performance Bonds are banks and surety companies.
Banks will generally take 100% cash collateral security for the duration of the contract. If you have that amount of cash in credit, this is a fantastic option as the bank will pay interest on the cash amount which will probably pay for the bond itself.
The downside to this arrangement could be a serious affect on your business’ cash flow for the duration of the contract as the cash is not immediately accessible. An overdraft facility can often be set up to resolve this but these usually need to be secured with personal guarantees or property. As a result, using a bank could end up more expensive and prohibitive.
Bonds and surety are a strange world and we often find that it is not until you are about to sign up with banks that they tell you about the cash collateral. Our best advice would be to check with them before signing anything.
Using a surety company, on the other hand, means that cash flow will not be affected and the cost of the bond will therefore stand apart from company banked finances.
The surety market, however, is international so care should be taken with the details. You should be especially aware where personal guarantees are requested. Should the product pay out, surety companies will seek recovery from individuals.
We would always recommend you get specialist advice on any surety product before purchase. As with most financial products, the devil is in the detail.
Other Kinds of Bonds
Advance Payment Bond – is bond to cover any advance a you may receive from your employer. Usually the advance is used to buy materials to get prepared for a job. These bonds will be 100% of the advance payment made.
Retention Bond – is a bond given to an employer in lieu of them holding monies against you. This can free up cash to assist with cash flow and is usually in the region of 2.5% to 5% of the contract value.
Performance Bonds Insurance - BJP Insurance Brokers 
