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TL;DR: A performance guarantee is a written undertaking by a bank or insurer to pay the employer an agreed amount if the contractor fails to perform the contract. On South African public sector work, the CIDB caps it at 10% of the contract price for a fixed guarantee and 12.5% for a variable one. Contractors pay a premium or fee for it, usually worked out as a percentage of the guaranteed amount, and it has to be in place within a set period after award, so it pays to arrange guarantee capacity before you tender.
Win a construction or engineering contract in South Africa and one of the first things the employer will ask for is security for your performance. In most cases that means a performance guarantee: a document from a bank or insurer promising to pay the employer if you do not deliver what the contract requires.
This guide explains what a performance guarantee is, how it works from tender to final completion, how large it usually needs to be, what it costs, and the other guarantees you are likely to meet on the same project. It is general information for contractors, sub-contractors and employers, not legal advice on a specific contract.
In this article
What is a performance guarantee?
A performance guarantee is a written undertaking by a bank or insurer (the guarantor) to pay the employer up to a stated amount if the contractor fails to perform its obligations under the contract. It protects the employer against the cost of a contractor defaulting, abandoning the works or becoming insolvent part way through a project.
There are three parties:
The contractor (sometimes called the principal), who arranges and pays for the guarantee.
The employer (the beneficiary), who can claim under it.
The guarantor, a registered bank or insurer, which pays the employer and then recovers what it paid from the contractor.
That last point matters. A performance guarantee is not insurance for the contractor. If the guarantor pays out, the contractor must reimburse it under the counter-indemnity it signed when the guarantee was issued.
How a performance guarantee works
On a typical South African construction contract, the guarantee follows the life of the project:
Tender. The tender documents state the form and amount of security required, usually in the contract data, and often include the exact wording the employer will accept.
Award. Once the tender is accepted, the contractor has a set period, stated in the contract, to deliver the guarantee. Failing to provide it can be a breach of contract in its own right.
During the works. The guarantee stays in force while the contractor performs. If the contractor defaults, the employer can call on it, following the procedure the guarantee sets out.
Completion. Depending on the contract, the amount may reduce at practical completion and again at final completion.
Release. The guarantee expires on the date or event it states, or is returned to the guarantor when the contract says security is no longer needed.
Expiry dates deserve attention. A guarantee with a fixed expiry date can lapse before the works are finished if the project runs late, and most contracts require the contractor to extend or replace it before it expires.
How much is a performance guarantee?
The amount is set by the contract, usually as a percentage of the contract price. Two South African benchmarks are worth knowing:
Public sector work. The Construction Industry Development Board’s Standard for Uniformity in Construction Procurement provides that guarantees must not exceed 10% of the contract price for a fixed guarantee, or 12.5% for a variable guarantee, and must be stated in the contract data. Where guarantees are provided, total retention held may not exceed 5% of the contract price.
JBCC building contracts. The JBCC Principal Building Agreement calls its performance security a construction guarantee, in either a variable or a fixed form. The variable guarantee starts at 10% of the contract sum and reduces as the works reach practical and final completion. The fixed guarantee starts at a lower amount and is supplemented by payment reductions deducted from interim payments.
Private employers and international forms of contract, such as FIDIC and NEC, set their own amounts, so always check the contract data rather than assuming 10%.
What does a performance guarantee cost?
Banks charge a guarantee fee and insurers charge a premium, in both cases usually calculated as a percentage of the guaranteed amount for the period the guarantee is in force. The rate depends on:
Your financial position. Latest annual financial statements, management accounts, net asset value and cash flow.
Your track record. Completed contracts of a similar size and type, and any history of disputes or calls on guarantees.
Work in hand. How many other projects you are running and how much guarantee capacity is already in use.
The guarantee wording. On-demand guarantees are riskier for the guarantor than conditional ones, which is reflected in the price and in the security asked for.
Duration and amount. Longer projects and larger guarantees cost more in total.
The fee is only part of the cost. A bank guarantee usually sits against your banking facilities, and may need cash or other security behind it. An insurance guarantee typically does not use bank facility lines, though the insurer will usually ask for a counter-indemnity and may ask for some security depending on your financial strength.
Performance guarantee, performance bond, construction guarantee: what is the difference?
Much of the confusion around performance guarantees comes from the number of names used for similar documents:
Term
Where you will see it
Performance guarantee
The general term in South African tenders, including CIDB public sector contracts.
Construction guarantee
The term used in JBCC building contracts.
Performance security
The term used in FIDIC and some other international contracts.
Performance bond
Common in the UK and internationally, and used informally in South Africa for the same instrument.
Surety bond
A bond issued by an insurer. In South Africa the term is also used for estate and executor bonds, which are unrelated.
The name matters less than the wording. Two documents both called a performance guarantee can behave very differently depending on the conditions for a claim.
On-demand and conditional guarantees
This is the most important distinction in any performance guarantee:
On-demand guarantees must be paid when the employer makes a demand that complies with the guarantee’s terms. The employer does not have to prove the contractor was in breach first.
Conditional guarantees only pay once the employer has shown the contractor defaulted and the employer suffered a loss, which makes them closer to a suretyship.
South African courts treat on-demand guarantees as independent of the construction contract. In Lombard Insurance Co Ltd v Landmark Holdings, the Supreme Court of Appeal confirmed that the guarantor must pay a valid demand without investigating the dispute between contractor and employer, and that fraud by the beneficiary is the exception. In Minister of Transport and Public Works v Zanbuild Construction, by contrast, the court read the wording of a construction guarantee as limiting the guarantor’s liability to the contractor’s liability under the contract, so the employer could not be paid without proving its claim.
Both banks and insurers can issue performance guarantees. The CIDB Standard for Uniformity accepts guarantees from an insurer registered under South African insurance legislation or a bank registered under the Banks Act, where the contract allows it.
Bank guarantees are familiar to employers, but usually reduce your available banking facilities and may need cash or asset security.
Insurance guarantees are usually issued without using bank facility lines, leaving those facilities free for working capital, plant and materials. The insurer underwrites your balance sheet and track record instead.
Check that the employer will accept an insurance guarantee and the insurer’s rating before relying on one. For growing contractors, the effect on facilities is often the deciding factor. Our guide to guarantees as credit instruments covers how to structure guarantee capacity across several projects.
Other guarantees on the same project
A performance guarantee is rarely the only security a contract asks for. You are likely to meet:
Tender or bid guarantee. Secures your tender, so the employer is protected if you withdraw or fail to sign the contract after award.
Advance payment guarantee. Secures an upfront mobilisation payment from the employer, and usually reduces as the advance is recovered from interim payments. It must normally be in place before the advance is released.
Retention guarantee. Replaces cash retention, so the employer releases retention money to you in exchange for a guarantee of the same value.
Payment guarantee. Some contracts, including the JBCC agreements, allow the contractor to ask the employer for security for payment, working in the other direction.
How to get a performance guarantee
The best time to arrange guarantee capacity is before you tender, not after award, when the deadline to deliver the guarantee is already running. A guarantor will usually ask for:
Latest audited or reviewed annual financial statements and recent management accounts.
A schedule of work in hand and completed contracts.
The tender or contract documents, including the contract data and the required guarantee wording.
Company registration details, CIDB grading where relevant, and details of directors and shareholders.
A signed counter-indemnity, and in some cases security, depending on your financial position.
Before you submit, check that the amount, wording, expiry date and guarantor all match what the contract requires. Employers can reject a guarantee that departs from the required form, and fixing it under deadline pressure is avoidable.
Berkley Risk arranges bond and guarantee insurance for South African contractors, including performance, advance payment, retention and tender guarantees, subject to underwriting and the insurer’s wording. Contact us to discuss your guarantee requirements before your next tender.
Frequently asked questions
What is a performance guarantee in a tender?
It is the security the employer requires from the successful tenderer to protect against the contractor failing to perform. The tender documents state the amount, the form and often the exact wording, and the contractor must deliver it within a set period after award.
Is a performance guarantee the same as a performance bond?
In practice, yes. Both describe an undertaking by a bank or insurer to pay the employer if the contractor defaults. South African contracts tend to say performance guarantee or, in JBCC contracts, construction guarantee, while performance bond is more common internationally.
How much is a performance guarantee in South Africa?
The contract sets the amount, usually as a percentage of the contract price. On public sector work, the CIDB caps it at 10% for a fixed guarantee and 12.5% for a variable guarantee. The JBCC variable construction guarantee starts at 10% of the contract sum and reduces as the works are completed.
Who issues performance guarantees?
Registered banks and insurers. Bank guarantees usually use the contractor’s banking facilities, while insurance guarantees typically do not. The contract may specify which guarantors the employer will accept.
Can the employer call a performance guarantee without proving breach?
If it is an on-demand guarantee, generally yes. The guarantor must pay a demand that complies with the guarantee’s terms, and South African courts have held that fraud by the employer is the main exception. A conditional guarantee only pays once the employer proves default and loss.
When is a performance guarantee released?
When the date or event stated in the guarantee is reached, or when the contract says the security is no longer required, commonly at practical or final completion. If the project overruns, the contractor may need to extend the guarantee before it expires.
What is the difference between a performance guarantee and an advance payment guarantee?
A performance guarantee protects the employer if the contractor fails to perform. An advance payment guarantee protects an upfront payment the employer makes to the contractor, and usually reduces as that advance is recovered from interim payments.
What does a performance guarantee cost?
It is usually priced as a percentage of the guaranteed amount for the period it is in force. The rate depends on the contractor’s financial strength, track record, work in hand, the guarantee wording and the duration. Bank guarantees can also carry the hidden cost of reduced banking facilities.
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