Commercial & Contract · Best Practice · Pre-Construction

Performance Bond

A bond provided by a surety guaranteeing payment to the client if the contractor fails to perform.

Last reviewed: 29 March 2026 — This guide reflects UK law as of this date. Contract Law / Surety remains current with no amendments enacted as of 29 March 2026. Next scheduled review: 29 March 2027.

Legal basis	Contract Law / Surety — a performance bond is a financial guarantee provided by a bank or insurer (the surety) on behalf of the contractor (the principal) in favour of the employer (the beneficiary)
Bond amount	Typically 10% of the contract value, though this can vary depending on the employer's requirements and the risk profile of the project
Bond type	On-demand bond (payable on first written demand without proof of default) or conditional bond (payable only on proof of contractor default)
Duration	Covers the full construction period plus the defects liability period (DLP) — the bond remains in force until all obligations are discharged or the bond is released
Cost	Borne by the contractor — typically 0.25% to 0.5% of the bond amount per year, depending on the contractor's financial standing and the surety's assessment

1. Performance Bond

A performance bond is a financial instrument that provides the employer with a guaranteed source of funds in the event that the contractor defaults on its obligations under the construction contract. The bond is issued by a bank or insurance company (the surety) on behalf of the contractor (the principal), and it operates as a promise by the surety to pay the employer (the beneficiary) a specified sum of money if the contractor fails to perform the contract. The purpose is to protect the employer against the financial consequences of contractor default — including the cost of completing the works, engaging an alternative contractor, and rectifying defective work.

The bond amount is typically set at 10% of the contract value, which is intended to cover the additional costs that an employer would incur in having the works completed by another contractor following a default. A performance bond does not guarantee that the works will be completed — it provides a financial safety net up to the bond amount. The employer must still arrange for completion of the works separately.

There are two main types of performance bond. An on-demand bond (also known as an unconditional bond) is payable on first written demand by the employer, without the need to prove that the contractor has defaulted or that the employer has suffered any loss. This gives the employer maximum security but places significant risk on the contractor and the surety. A conditional bond (also known as a default bond) is only payable where the employer can demonstrate that the contractor has defaulted on its obligations and that the employer has suffered loss as a result. The conditional bond is more common in UK construction contracts, as it provides a fairer balance of risk. The calling procedure — the precise steps the employer must follow to make a valid demand on the bond — must be followed exactly, or the surety may refuse to pay.

Bond cost is priced into the tender

The cost of obtaining a performance bond is borne by the contractor, but it is invariably priced into the contract sum as part of the contractor's preliminaries. The annual premium is typically 0.25% to 0.5% of the bond amount, depending on the contractor's financial standing and credit rating with the surety. Employers should be aware that requiring a bond adds cost to the project — but this cost is modest compared to the financial exposure if the contractor defaults without a bond in place.

2. Key Terms

The following terms are commonly found in a performance bond. Understanding each term is essential to ensure that the bond provides the intended level of protection and that any demand is made correctly.

Term	Explanation
Principal	The contractor on whose behalf the bond is issued. The principal is the party whose performance is guaranteed by the surety. If the principal defaults on its contractual obligations, the surety becomes liable under the bond.
Obligee / Beneficiary	The employer or client in whose favour the bond is issued. The beneficiary is the party entitled to make a demand on the bond if the contractor defaults. Only the named beneficiary (or its assignee, if assignment is permitted) may call on the bond.
Surety / Bondsman	The bank, insurance company, or specialist surety that issues the bond and guarantees the contractor's performance. The surety undertakes to pay the bond amount to the beneficiary in the event of a valid demand. The surety's financial strength underpins the value of the bond.
Bond amount	The maximum sum payable under the bond, typically 10% of the contract value. The bond amount is a cap — the surety's liability does not exceed this sum regardless of the employer's actual losses.
Obligations guaranteed	The specific contractual obligations that are covered by the bond. Typically, the bond guarantees performance of the contractor's obligations under the construction contract, including completion of the works, rectification of defects, and compliance with the contract terms.
Bond type	On-demand (unconditional) — payable on first written demand without proof of default. Conditional (default) — payable only on proof that the contractor has defaulted and the employer has suffered loss. The bond wording determines which type applies.
Calling procedure	The specific steps the employer must follow to make a valid demand on the bond. This typically includes serving a written demand on the surety, stating the nature and extent of the contractor's default, and (for conditional bonds) providing evidence of default and loss. Failure to follow the calling procedure precisely may invalidate the demand.
Duration	The period during which the bond remains in force. A performance bond typically covers the full construction period plus the defects liability period. The bond may contain an expiry date or may remain in force until all obligations are discharged or the bond is formally released.
Applicable law	The law governing the bond instrument. In the UK, performance bonds are governed by English law (or Scots law in Scotland). The bond is a separate contract from the underlying construction contract, though it references and is dependent upon that contract.
Surety's rights	The surety typically has the right to take over the contractor's obligations and complete the works rather than pay out under the bond (right of subrogation). On paying out, the surety acquires the right to recover the amount paid from the contractor.

3. Common Mistakes

Not obtaining the bond before construction starts

The performance bond must be in place before the contractor commences work on site. If the bond is not obtained until after construction has started, there is a gap in the employer's financial protection during the early stages of the project. If the contractor defaults during this period, the employer has no bond to call on. Contract conditions typically require the bond to be provided within a specified number of days after contract execution and before the contractor takes possession of the site. The employer should not allow the contractor to start work until the bond has been received and confirmed as being in order.

Not following the calling procedure precisely

A demand on a performance bond must comply exactly with the calling procedure set out in the bond instrument. For a conditional bond, this typically requires the employer to serve a written demand on the surety stating the nature of the contractor's default, the losses suffered, and the amount claimed. For an on-demand bond, the demand must be in the form specified in the bond wording. If the employer fails to follow the correct procedure — for example, by serving the demand on the wrong party, using incorrect wording, or failing to provide the required evidence — the surety may reject the demand. Legal advice should be taken before making any demand on a performance bond.

4. Frequently Asked Questions

What is a retention bond?▾

A retention bond is a financial guarantee that allows the employer to release retention monies to the contractor before the end of the defects liability period, while retaining the right to recover those monies if the contractor fails to rectify defects. Under a standard construction contract, the employer withholds a percentage of the contract sum (typically 3% to 5%) as retention, half of which is released at practical completion and the remainder at the end of the defects liability period. Retention can represent a significant cash flow burden on the contractor. A retention bond replaces the cash retention with a bond from a bank or insurer — the contractor receives the retention monies earlier, and the employer holds the bond as security instead. If the contractor fails to rectify defects during the DLP, the employer can call on the retention bond to recover the cost of remedying those defects.

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