What is a performance bond?
Performance bond · PB
A bank guarantee, normally one to two per cent of contract value, that pays the buyer if the seller fails to perform. It is the seller’s counterweight to the buyer’s letter of credit.
Key points
- Typically 1–2% of contract value; a penalty, not full compensation.
- On-demand bonds pay without proof of breach — a real seller exposure.
- Insist on a stated expiry and a release obligation on completion.
At a glance
| Issued by | The seller’s bank, in the buyer’s favour |
|---|---|
| Typical size | 1–2% of contract value, up to 5% on long-term supply |
| Types | On demand, or conditional on proof of breach |
| Governing rules | URDG 758, or ISP98 / UCP 600 for standby credits |
| Must specify | Expiry date and release on completion |
Balancing the instruments
In a documentary trade the buyer takes most of the visible risk: it opens a letter of credit, ties up a facility, and pays against documents. The performance bond is what the seller puts up in return — a bank guarantee that pays the buyer a stated sum if the seller does not ship as contracted.
The usual size is one to two per cent of contract value, sometimes up to five for a long-term supply commitment. It is not intended to cover the buyer’s full loss. It covers the immediate consequences of a failure to perform — replacement at a worse price, freight already booked, a vessel waiting — and it makes non-performance cost the seller something.
On demand or conditional
An on-demand bond pays when the buyer demands payment, without proving breach. The bank checks the demand is in order and pays. It is strong protection for the buyer and a real exposure for the seller, since a buyer in dispute can call it while the argument is unresolved.
A conditional bond requires evidence — an arbitral award, or documents showing the failure. It is fairer to the seller and much slower for the buyer. Which applies should be explicit in the SPA, and a seller agreeing to an on-demand bond without a cap or an expiry has taken on more than it may realise.
What to check before issuing one
The expiry date and the return mechanism. A bond that does not expire, or that the buyer is not obliged to release on completion, ties up the seller’s facility indefinitely. A stated expiry with automatic lapse is standard and worth insisting on.
The trigger and the governing rules. Bonds are usually issued under URDG 758 or as standby credits under ISP98 or UCP 600, and the rule set determines how a demand is examined. And, as with any instrument, whether the issuing bank is one the beneficiary would take exposure to — a bond from a bank nobody will confirm is worth about as much as the paper.
Frequently asked questions
- How much is a performance bond usually worth?
- One to two per cent of contract value is standard for a spot cargo, and up to five per cent for long-term supply. It is calibrated to make non-performance costly rather than to cover the buyer’s whole loss.
- What is the difference between on-demand and conditional?
- An on-demand bond pays on a compliant demand, without the buyer proving breach. A conditional bond requires evidence, often an arbitral award. On-demand favours the buyer; conditional favours the seller. The SPA should say which applies.
- Does a performance bond replace a letter of credit?
- No — they protect opposite parties. The letter of credit protects the seller against non-payment; the performance bond protects the buyer against non-delivery. A balanced contract often has both.
Related terms
The contract itself — the first document in the sequence that actually binds the parties. Everything exchanged beforehand is superseded by it, and any term not carried into it has no effect.
A bank undertaking to pay the seller once compliant documents are presented. It substitutes the bank’s credit for the buyer’s, which is why it remains the default instrument between counterparties trading together for the first time.
The window of days within which the vessel must arrive and be ready to load. Miss the laycan and the charterer may cancel; arrive early and the vessel waits at the buyer’s or seller’s expense depending on terms.
A daily charge payable when loading or discharging takes longer than the agreed laytime. On bulk cargoes it can move the economics of a shipment materially, which is why laytime terms belong in the contract, not the covering email.
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