What Are Performance Bonds?
Performance bonds are a type of guarantee provided by an insurer, bank or other guarantor that ensures that goods or services are provided in accordance with a contract. The issuing party agrees to pay the buyer an agreed-upon amount of money in the event that such goods or services are not delivered on time or according to the contract.
It’s important for all parties to understand that performance bonds are not insurance products. As such, they are not subject to the insurance premium tax. Organisations may often choose to use their bank in order to sponsor bonds, but it’s important that they are aware of any potential cash collateral that may be required.
One frequent use of performance bonds can be observed in the construction industry. A guarantor may provide bonds on behalf of a contractor in order to provide financial security for a construction firm.
Different Types of Bonds
Performance bonds can be complicated, and there are different types that guarantors may choose to utilise. It’s important for all parties to understand how the following types of bonds work:
- Conditional bond—These bonds may require litigation before payment can be made. Insurance providers usually issue conditional bonds with payment being dependent upon the beneficiary providing proof of their losses. Conditional bonds are commonly used in the construction sector.
- On demand bonds—This type of performance bond is common in the petroleum and power industries. They are often a standard requirement for international contracts and are usually provided by banks. Guarantors are required to make a payment under the bond whenever one is demanded.
In the UK, performance bonds usually cover approximately 10 per cent of a contract’s value, but some organisations may require 15 per cent. This amount can be altered to any amount as long as all parties are in agreement.
The cost of performance bonds is typically a percentage of their face value, with longer bond periods generally resulting in higher rates. Other factors may include the specific wording of a contract and the experience and financial standing of the contractor.
For more information on performance bonds, contact us today.