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Performance bond for construction

A performance bond is commonly used in


the construction industry as a means of insuring
aclient against the risk of a contractor failing to
fulfil contractual obligations to
the client.Performance bonds can also be
required from other parties to a construction
contract.
Whether or not a performance bond is required
will depend, in the main, on the perceived
financial strength of the party bidding to win
a contract, as the most common concern relates
to a contractor becoming insolvent before
completing the contract. Where this occurs
the bondprovides compensation guaranteed by
a third party up to the amount of
the performance bond.Bonds are typically set at
10% of the contract value. This compensation
can enable the client to overcome difficulties
that have been caused by non-performance of
the contractor, such as, for example, finding a
new contractor to complete the works.

Bonds can be 'on demand' or 'conditional', with


conditional bonds requiring that
the client provides evidence that
the contractor has not performed their
obligations under the contract and that they
have suffered a loss as a consequence.
The obligation for the contractor to provide
the client with a bond is set out in tender
documents. The choice of bondsman and terms
in regard to cost falls entirely to
the contractor who secures it prior to the start of
work. From a client viewpoint it is wise to
stipulate that the bond stays in place until the
end of the defects liability period when the final
certificate is issued.
Bonds can be issued either by
an insurance company or by a bank, and the
cost of the bond is usually borne by
the contractor (albeit, this is likely to be
reflected in the contractor's tenderprice). The
cost of the bond gives the client a good guide as
to the credit worthiness and reputation of
the contractor in the bond market, which will
view each contractor differently in respect of
its history, management and financial health.

Strictly speaking the bond is a guarantee and as


such is a contingent liability in regard to
thecontractor's balance sheet. A
smaller contractor might face a limit on how
many bonds it can take out.
The contractor sends the bond document to the
beneficiary ie the client who holds it until the
end of the defects liability period.
The bond is related to the contract
conditions and the courts take a view that
the bondsman has little protection against
adverse risk. So it is wise to seek
the bondsman's consent before acting outside
the contract conditions, for example by paying
the contractors in advance of work undertaken
to ease its cash flow difficulties. Such conduct
could jeopardise a subsequent claim on
the bond.