Performance security: Overview, definition, and example
What is performance security?
Performance security is a financial guarantee that ensures a party will fulfill its obligations under a contract. It’s commonly used in construction, supply agreements, and large service contracts to protect the party receiving the service or goods. If the obligated party fails to perform as agreed, the security can be used to cover losses or complete the project.
Performance security can take different forms, such as a bank guarantee, performance bond, or cash deposit. It acts as a safety net, giving the other party confidence that the work will be completed as promised.
Why is performance security important?
In business, contracts often involve significant financial commitments and long timelines. Performance security helps minimize risk by ensuring that if a contractor, supplier, or service provider fails to meet their obligations, there is financial backing to address the shortfall.
For example, in a construction project, if a contractor abandons the job or delivers subpar work, performance security allows the client to recover costs and hire another contractor to complete the work. This is especially important for SMBs that may not have the financial resources to absorb losses from a failed contract.
Understanding performance security through an example
Imagine you own a manufacturing business and hire a contractor to build a new production facility. You require the contractor to provide a performance bond equal to 10% of the total contract value.
Halfway through the project, the contractor goes bankrupt and stops work. Because you have a performance security clause in your contract, you can claim the bond and use the funds to hire another contractor to finish the project—without taking a huge financial hit.
Without performance security, you might have to cover the extra costs yourself, which could seriously impact your business.
An example of a performance security clause
Here’s an example of how a performance security clause might appear in a contract:
“The Contractor shall provide a performance bond or bank guarantee in the amount of [percentage]% of the total contract value, valid for the duration of the project. In the event of the Contractor’s failure to perform in accordance with this Agreement, the Client shall have the right to claim the performance security to recover costs and complete the required work.”
This clause ensures that the client has financial protection if the contractor does not fulfill their obligations.
Conclusion
Performance security is a key safeguard in contracts, ensuring that businesses don’t suffer losses due to non-performance. For SMBs, requiring performance security in agreements with contractors or suppliers can help manage risk and provide peace of mind.
If you’re entering into a contract where failure to perform could result in significant financial losses, consider including a performance security clause. It’s a simple but powerful way to protect your business and ensure that agreements are honored.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.