"The name is Bond..."

Employers under construction contracts often try to protect themselves against the risk of loss from a variety of events by asking the contractor for a performance bond.

A performance bond is a form of security provided by a third party, usually a bank or insurance company, guaranteeing the obligations of the contractor under the contract. A bond constitutes a promise that the guarantor (i.e. the bank/insurance company) will make a payment to the employer of a set amount (usually 10% of the contract value).

Although the concept seems straightforward, there are numerous types of performance bonds and the differences are not always obvious.

On Demand Performance Bonds

A true 'on demand' bond provides that the guarantor will pay to the employer the sum specified in the bond, i.e. without consideration of the contractual position of the parties, what the contractor has done and any associated liability, or any actual loss suffered by the employer. As such, on demand bonds give rise to the possibility of the employer issuing a demand to the guarantor where the contractor is not in breach of contract or insolvent and no loss has been suffered. It is easy to see why such bonds are rare in the domestic construction industry nowadays (they are more often seen in international construction contracts).

Conditional Performance Bonds

'Conditional' bonds are more often seen in domestic construction contracts and usually provide that the guarantor will pay the bond amount to the employer provided that certain conditions have been fulfilled. Usually, such conditions would be the contractor's insolvency or breach of contract. This means that the employer will have to prove its loss before receiving any monies payable under the bond.

Separately in respect of conditional bonds, case law has shown that any change to the original construction contract can allow the guarantor to escape its obligations under the bond, unless the guarantor's consent to any variation was obtained. Therefore employers agreeing to contract amendments during the construction period when they have the benefit of a performance bond should take care.

If you are embarking on a construction project and wish to have further information on protecting your position, please contact our team.