Are you planning a construction or fit-out project and have been told by your lender that you need a ‘performance bond’? Has your contractor asked you to accept a performance bond and you want to understand what it really means before signing? Or are you simply looking at ways to protect your project and make sure it stays on track? Then you have come to the right place. Performance bonds and guarantees are increasingly important in today’s market. With contractor insolvencies on the rise, supply chain delays, and funders more cautious than ever, they give developers and lenders peace of mind that a project won’t be derailed if the contractor can’t deliver.
In this guide, our experienced commercial property solicitors explain the essentials: when performance bonds are used, how they work, and the key points to check before committing.
If you are planning, negotiating or funding a construction project, understanding performance bonds is vital. We’ll walk you through the legal detail, help you avoid unnecessary risks, and give you the confidence to protect your investment and keep your project on track.
Contents:
- What is a performance bond?
- Why are performance bonds so important in construction projects?
- What types of performance bond are?
- Who typically arranges and pays for a performance bond?
- Do I need a performance bond for my building project?
- How does a performance bond work in practice?
- Negotiating terms of a performance bond
- How long should a performance bond last?
- Can you cancel a performance bond?
- What happens when the performance bond expires?
- How to enforce a performance bond
- Summary
- Key takeaways:
- How we can help
What is a performance bond?
A performance bond is like a financial guarantee, typically covering a percentage of the contract value. For example, if your project is worth £2 million, the bond might protect you for up to £200,000. It is usually provided by a bank or insurer, on behalf of a contractor of a construction project for the benefit of the developer. Performance bonds can also be a requirement where a development is being funded by a lender.
It effectively serves as a safety net if the contractor doesn’t complete the work properly or fails to finish the project. In that situation, the developer can make a claim on the bond to recover the cost of putting things right or bringing in a replacement contractor.
While they have traditionally been used in larger public sector projects where public funds are at stake, performance bonds are now increasingly required by lenders for smaller private developments too.
Why are performance bonds so important in construction projects?
Construction projects are often high-stakes, and both developers and lenders need reassurance that their money is protected. If the original contractor fails to deliver or goes out of business, the costs of delays, additional works, or hiring a replacement can be significant. A performance bond ensures funds are available to cover these risks and enable the satisfactory completion of the project.
Think of it as risk mitigation. Put simply, without a performance bond, if your contractor defaults, you may be left funding the extra costs yourself or relying on litigation, which can be slow and expensive. A bond provides a ready source of funds to keep your project moving.
In recent years, the construction sector has faced higher insolvency rates, inflationary cost pressures, and ongoing supply chain disruption. Funders are responding by making performance bonds a standard requirement even on SME-scale projects. This means developers and employers are more likely than ever to encounter bonds when negotiating contracts or seeking finance.
What types of performance bond are?
There are two main types of performance bonds/guarantees you are likely to come across:
Conditional (also called ‘default’ or ‘guarantee’ bond)
- Works like an insurance policy against contractor default (missed deadlines, poor workmanship, insolvency etc.)
- Only pays if you can provide concrete proof of the default, such as evidence of delays, lack of progress, or other substantial breaches of the contract terms.
- The payout is limited to the actual loss you can show, up to the maximum bond amount.
On Demand bond
- Usually provided by the contractor’s bank (unlike a conditional bond).
- Allows you to ‘demand’ payment of the full bonded sum without having to prove default.
What are the key differences between an on-demand and a conditional performance bond?
| Feature | Conditional (Default/Guarantee) Bond | On-Demand Bond |
|---|---|---|
| How it works | Employer must prove the contractor has failed (e.g. delays, defects, insolvency) | Employer can demand payment without proving default |
| Proof required? | Yes - evidence of breach is needed | No - payment is made on request (subject to bond terms) |
| Ease of claiming | Slower and potentially more disputed | Faster and more straightforward |
| Typical use | Smaller or private projects | Larger, high-value, or funder-led projects |
| Cost | Usually cheaper | More expensive (higher risk for the bank/insurer) |
| Risk to employer | May face delays when claiming | Easier to access funds, but usually harder for contractors to obtain |
Who typically arranges and pays for a performance bond?
The contractor arranges the performance bond, usually with a bank or insurer. However, the cost is normally built into the contractor’s price - so in practice, the employer/developer (you) ends up paying for it.
Premiums vary depending on the contractor’s financial strength and the type of bond, but as a rule of thumb, they cost a one-off fee linked to the bond value. For a typical 10% bond, this is a small percentage of the contract price.
Do I need a performance bond for my building project?
You may be asked for (or want to request) a performance bond in situations such as:
- Lender requirement - many funders now insist on a bond before releasing finance.
- High-value or high-risk projects - especially where delays or defects would be costly.
- Unfamiliar or financially weak contractors - bonds provide extra comfort where there’s uncertainty about the contractor’s stability.
- Public sector or local authority work - standard safeguard on publicly funded projects to protect interests of taxpayers.
If you’re new to development, it can be tempting to think a performance bond is only for big public projects. But even for smaller builds-like a hotel refurbishment, care home extension, or office fit-out-a bond can be a crucial safeguard if your contractor runs into trouble.
How does a performance bond work in practice?
If it’s an on-demand bond, the employer can claim directly from the bank/insurer as soon as the contractor defaults, provided the claim follows the bond’s wording.
If it’s a conditional bond, the employer must prove the contractor has failed e.g. missed deadlines, defects, insolvency. Normally the contractor is given a short window to fix the problem before a claim is accepted.
Once the claim is valid, the bank or insurer either:
- Pays compensation to cover the employer’s extra costs; or
- Steps in to appoint another contractor to complete the works.
Negotiating terms of a performance bond
Performance bonds are usually issued on standard templates prepared by banks or insurers, but the details can often be negotiated. The wording really matters because small differences can affect how and when you can make a claim.
Some of the key points to look out for are:
- Scope and amount - How much of the contract value is covered? Bonds are often set at 10%, but this can vary depending on the size and risk of the project.
- Duration and expiry - Does the bond last until the project is finished? Does it also cover any defects period afterwards? Make sure the end date matches the actual risks on your project.
- Termination - Under what circumstances can the bond be cancelled?
- Claims process - How quickly do you need to notify the surety of a problem, what evidence do you need, and how will the claim be dealt with?
Because the bond is normally drafted by the surety (the bank or insurer), it’s important to have the wording reviewed before you sign.
At Harper James, we regularly help clients navigate bond terms. These documents can be long and complex, but we can:
- Check that the bond reflects what was agreed.
- Highlight any unusual or restrictive terms.
- Draft clear, tailored bond agreements where needed.
Getting advice at this stage can give you peace of mind and reduce the risk of problems later.
How long should a performance bond last?
This depends on the specific scope, complexity and timeline of the construction project. Most performance bonds run until the project is completed to the employer’s satisfaction. Sometimes they also cover a maintenance or defects period after completion, when the contractor is still responsible for fixing issues.
The exact duration should always be agreed at contract stage. A bond that ends too early may leave you unprotected if problems appear late in the build.
Can you cancel a performance bond?
Bonds can usually only be cancelled if both the employer and contractor agree. Even then, the wording of the bond may set conditions.
If you are considering cancelling a bond, get legal advice before doing so. Ending protection too early could expose you to unnecessary risk.
What happens when the performance bond expires?
When the bond expires, the bank or insurer is released from any further liability. This is normally when the project reaches practical completion, or at the end of the defects period if that is included.
Always check the expiry date and make sure it aligns with the actual risks on your project.
How to enforce a performance bond
Enforcing a bond can feel daunting, but in practice it follows a clear process:
- Step 1: Identify the problem
- First, work out what has gone wrong. You need to show that the contractor is in breach and pinpoint the specific failure. Common issues include the contractor going bust, serious delays, poor workmanship, or not finishing key tasks.
- Step 2: Check the bond wording
- Look at the wording of your bond and contract. Each bond sets out the exact situations where you can make a claim, how quickly you must act, and what information you need to provide.
- Step 3: Notify the bank/insurer promptly
- Notify the bond provider as soon as possible, following any deadlines or notice requirements in the bond. Be ready to share evidence such as project records, emails or site reports.
- Step 4: Investigation
- The bank or insurer will review your claim and decide whether the contractor has defaulted.
- Step 5: Outcome
- If your claim is accepted, the bond provider will pay you compensation to cover costs of completing the project or rectifying any damages. They may step in to arrange another contractor to finish the job.
Tip: Timing is critical. If notice periods or documentation requirements are missed, your claim could fail. This is where legal advice makes all the difference. Our experienced commercial property solicitors can guide you through the process and help you enforce your rights under a performance bond.
Summary
In simple terms, a performance bond is a safety net. It’s there to protect you if your contractor can’t finish the job or runs into serious problems. This is especially important on bigger or publicly funded projects, where the financial stakes are high - but more and more private funders are asking for them too.
The key is to make sure the bond is clear about what it covers, how long it lasts, and how you can make a claim if needed. Getting the wording checked at the contract stage can save you a lot of time, money and stress later.
Key takeaways:
- A performance bond acts as a financial safety net if your contractor fails to deliver.
- Bonds are increasingly required by funders due to rising insolvencies and supply chain risks.
- Two main types exist: conditional (proof required) and on-demand (payment on request).
- Most bonds cover around 10% of the contract value and last until project completion or the end of a defects period.
- Always review the bond wording carefully , including any specific conditions or processes to follow to make a claim - small differences can have a big impact on your protection.
Next step: If you are at the negotiation stage of a project and have been asked to provide or accept a performance bond, speak to your solicitor before signing. The cost of early advice is far less than the risk of being left unprotected.
How we can help
We work with developers, employers and contractors to understand and manage performance bonds. These documents can be long and technical, but our construction solicitors can:
- Review bond agreements to make sure they reflect what was agreed and give you the protection you expect.
- Spot hidden risks by highlighting any unusual or overly restrictive terms.
- Draft clear, practical bond agreements where needed, tailored to your project.
- Guide you through negotiations with contractors, funders or banks.
Whether you’ve been asked to provide a bond, accept one, or simply want to know if it’s right for your project, we can give you straightforward advice at the early stages - helping you reduce risk and avoid costly surprises later. Get in touch to speak to one of our experienced commercial property solicitors today.
