What Is a Performance Bond?

The short answer

A performance bond supports the Principal's performance of the bonded contractual obligation, subject to the bond terms, the underlying contract and the surrounding circumstances. It gives the Obligee a defined surety undertaking if the Principal fails to fulfill the obligation described in the bond.

It does not guarantee that a project will succeed, that work will be completed automatically, or that the Obligee is paid immediately on demand. The bond must be read together with the contract and its own conditions.

What a performance bond is

A performance bond is normally connected to an awarded contract. It is used where the Obligee wants assurance that the Principal will perform the contract obligation that has been bonded.

The Principal is usually the contractor, supplier or service provider that has been awarded the work. The Obligee is the project owner, procuring entity, buyer or other party requiring the bond. The Surety issues the bond and undertakes the obligation stated in that bond, up to its amount and subject to its terms.

The obligation it supports

The underlying obligation belongs to the Principal under the contract. The Surety's undertaking under the bond is separate and defined by the bond wording. A performance bond commonly relates to the Principal's performance of the awarded work, supply or service, but the exact scope depends on the contract and the bond form.

This distinction matters. A contract may contain many duties, remedies and liabilities. The bond does not automatically absorb every contractual consequence. It supports the bonded obligation in the manner stated in the bond.

When it may be required

A performance bond may be required after award, before contract signing, before a notice to proceed, or at another point stated in the contract or bidding documents. Public and private contracts may use performance security, but the acceptable forms, amount, validity and wording depend on the applicable rules and documents.

The requirement document should be reviewed before applying, because some Obligees prescribe their own bond form or wording.

How a performance bond generally works

The Principal submits the notice of award, contract, required bond wording and supporting documents to the applicable insurer or Surety. The insurer evaluates the application, including the applicant, the contract, the bond amount, the validity period and the obligation being bonded. Evaluation, underwriting, requirements, terms, pricing, approval and issuance remain functions of the insurer or Surety.

If the Principal performs, the bond ordinarily runs until expiry, release or discharge according to the applicable documents. If the Principal is alleged to have defaulted, the Obligee may pursue the remedies provided by the bond and contract. The Surety's response depends on the documents, the facts, the bond terms, the contract and applicable law.

Important limitations and distinctions

A performance bond is not a project-management tool and not a substitute for contract administration. It does not guarantee workmanship after completion in the way a warranty or maintenance bond may. It does not necessarily cover unpaid subcontractors or suppliers unless the bond wording provides for that. It is also not a funding facility for the Principal.

For a broader explanation of why a bond does not guarantee project success, see the related Chapter 1 guide on that topic.

Practical points applicants should check

• The exact Obligee name and contract reference.
• The required amount, validity period and expiry or release conditions.
• Whether the Obligee prescribes a specific bond form.
• Whether extensions of time also require bond extensions.
• Whether other bonds are required alongside it, such as advance payment, payment or warranty bonds.
• Whether the contract terms create risks the insurer may need to evaluate closely.