A Guide to Performance Bonds & Guarantees in Construction
Construction projects are frequently high-risk and characterised by long timelines, multiple contractors, and delays due to supply chain disruptions. In recent times, insolvencies have been another cause of concern for developers and investors.
Because construction contracts can take a long time to reach fruition, investing money is a risky endeavour. Performance bonds and guarantees play a crucial role in protecting owners and developers against potential financial losses resulting from unforeseen issues.
Our expert construction litigation team act in construction disputes and adjudications across the country in a range of situations. If you are facing a dispute or risk of dispute- we’d love to assist you.
This article examines the various types of performance bonds utilised in construction, their operational mechanisms, and associated costs. We also consider whether they are the same as guarantees.
What Is a Performance Bond and How Does It Work?
A performance bond serves as a contractual guarantee for a specified percentage of the project’s value. It covers the risk that a contractor or supplier won’t meet their obligations under the construction contract.
There are three parties involved in this arrangement. The principal is the party who must provide the bond, usually a supplier or the contractor. The beneficiary is the project owner or the employer. The surety is the insurance company or bank.
Most construction contracts now require the contractor to obtain a performance bond. The contractor arranges this with a surety, naming the principal as the beneficiary.
The arrangement protects the developer or project owner from a failed practical completion due to defects or the insolvency of the contractor’s business. If the project fails within the agreed timeframe, surety compensates the developer.
The developer can claim on the bond up to its value to cover the costs of remedying defects or poor workmanship, delays, or hiring another contractor to finish the job.
There are two types of performance bond: one that is conditional and only pays out if the project owner can prove fault, and the other, which is on-demand, releasing money as soon as the contractor defaults.
With a conditional bond, the contractor is typically given a short timeframe to remedy the problem; failing which, the claim is accepted.
Who Provides Performance Bonds—and Who Benefits?
An insurance company or bank usually provides a performance bond on behalf of a contractor. The arrangement benefits the project owner or developer, providing a safety net to protect against additional costs associated with achieving practical completion.
Performance bonds, once reserved for large-scale public projects, are becoming increasingly common. Even for small, private developments, these may be a requirement insisted on by lenders and finance companies.
A contractor can also benefit from offering a bond at the bid stage. It demonstrates financial security and a commitment to the project. With a business that is not well-established, a performance bond can be the assurance needed to secure that bid.
However, if the surety must pay out, then they will pursue the contractor via indemnity to recover this payment.
Typical Bond Coverage and What It Costs
The contractor arranges the bond and builds the cost into the contract price, so it’s the developer or employer who ultimately pays for it.
Most bonds begin life as pro forma documents, but they do require skilled negotiation; the devil is always in the details. For instance, the bond’s expiration date must align with the project’s timeline and risk.
The terms and conditions will likely favour the issuer, so it’s vital to have the wording reviewed before signing.
The provisions should include the circumstances under which either party can terminate the bond, as well as the claims process, particularly in terms of the evidence required. It may be desirable for the bond to cover any defects that occur during the period following the project’s completion.
A typical bond is referred to as a 10% bond, which is set at 10% of the contract price and has a premium, averaging 1%-3% of the bond value, paid upfront annually.
It’s possible to alter the standard coverage of 10% if the size or risk of the project demands it. In high-risk sectors and projects, amounts can be as much as 20%.
The premium cost varies, reflecting the terms, the provider, the type of project, and the contractor’s financial status and creditworthiness. Some bond providers require collateral for security, such as director guarantees or company assets.
A rise in insolvencies in 2025 has created uncertainty and impacted the availability of bond providers in the market.
Conditional vs On-Demand Bonds: What’s the Difference?
The key difference between a conditional bond and an on-demand bond is that a conditional bond requires proof that the contractor has failed to perform the work. Defects, delays, or business insolvency may cause that default.
With an on-demand bond, payment is made at the developer’s request, subject to the terms and conditions of the agreement. Unsurprisingly, claiming under a conditional bond can take more time and may be challenged by the contractor.
The ease of access to funds for the developer with a performance bond is inevitably reflected in the cost; conditional bonds are typically less expensive.
Increasingly, conditional bonds are becoming associated with small or private projects: high-value or large developments, particularly those funder-led, favour performance bonds.
With a conditional bond, as well as proving contractor failure, the developer must also demonstrate that this has led to quantifiable losses.
Where Performance Bonds Are Used: Sectors and Project Scales
Performance bonds are typically associated with public sector projects, as an added layer of protection for taxpayers’ money. However, performance bonds may be a requirement in other scenarios, including for SME developments.
Private high-value or high-risk developments may also require a performance bond in scenarios where delays, defects, or disputes over completion would be costly.
Some lenders now demand a performance bond before releasing funds.
Performance bonds are also sometimes required by overseas clients to meet international standards for risk safety.
Frequently Asked Questions
What Are the Two Types of Bonds in Construction?
The first type is a default or guarantee bond, also called a conditional bond. It’s like an insurance policy against poor workmanship or total contractor failure. The project owner must provide proof of default or breach of contract to be eligible to claim. The second type is an on-demand bond, which allows for unconditional payment without requiring proof of default.
Is a Performance Bond the Same as a Guarantee?
No, here’s how they differ. You can claim against a bond without needing to prove breach of contract if it’s an ‘on-demand’ bond. With a guarantee, the party claiming must demonstrate non-performance. Guarantees and conditional bonds are similar in that they both require evidence of default or breach of contract.
What Are the Rules for Performance Bonds?
Performance bonds may be mandatory for large public projects involving local government organisations and councils to protect public funds. The type of bond dictates how it works and when/if it pays out. Many smaller projects now require performance bonds, and they are increasingly popular amongst funded developments.
Legal Guidance Ensures Compliance, Mitigates Risk, and Protects Investments
If you’re involved in construction projects of any size, then understanding your risk exposure is critical. Helix Law’s expert construction litigation team works with contractors, suppliers, developers, and project owners in the construction industry. We deal with a considerable number of high level adjudications and enforcement of adjudications in the High Court, arising out of development sites across the country. We review agreements to ensure that our clients are appropriately protected and aware of the risks involved. Whether you’re negotiating a bond or are already at the point of needing to consider a referral and/or an adjudication obtaining legal advice is essential to protect and improve your position. Our construction litigation team are experienced in construction disputes including where there are tens of thousands to tens of millions in dispute. They routinely offer alternative funding where we’re paid based on the results we achieve. We’d love to assist you- contact Helix Law today.
