What is a Performance Bond?
A performance bond is a guarantee issued by a bank or insurer on behalf of the seller, promising to pay the buyer a stated sum if the seller fails to perform its contractual obligations. It is security against non-performance, not a payment mechanism.
At a glance
| Term | Performance Bond |
|---|---|
| Definition | Bank guarantee that the seller will perform the contract; usually 2% of cargo value. |
| Category | Payment & banking |
| Related terms | LC (Letter of Credit), MT-103, MT-700, MT-799, T/T Payment, POF (Proof of Funds), BCL (Bank Comfort Letter) |
What it is used for
In commodity supply contracts a performance bond balances the buyer's payment commitment. Where the buyer opens a documentary credit, the seller commonly issues a performance bond as the reciprocal assurance that the cargo will actually be delivered.
Key points
- Commonly set at around 2% of the contract value, though anything from 1% to 10% is seen.
- Usually issued as a demand guarantee, payable on the buyer's compliant written demand.
- Issued via SWIFT MT760 or as a paper guarantee, with a defined expiry date.
- The seller's bank will require collateral or a credit line, so the bond ties up the seller's facilities.
What to watch for
- Understand whether the bond is on-demand or conditional — an on-demand bond can be called without proving loss.
- Match the expiry to the real delivery schedule, allowing for laycan slippage and delays.
- Bonds are frequently requested before a contract exists. Never issue one before the underlying terms are agreed and signed.
Frequently asked questions
Who pays for a performance bond?
The seller, since it secures the seller's performance. The cost is normally priced into the offer.
What is the difference between a performance bond and a standby letter of credit?
Commercially they do very similar work. The differences are legal and procedural — the governing rules, the issuing format and the jurisdictions where each is customary.
Can a performance bond be called unfairly?
An on-demand bond can be called on presentation of a compliant demand, which is why the calling conditions should be negotiated carefully.
Related terms
Lodfy verifies every company on the platform — registration, ownership and sanctions screening — before they can trade.