Could the contractor take the work on?
The bid assessment established that it could. The authority assessed the contractor's standing when the bid came in.
Net Worth & Solvency Glossary · Solvency & Courts
Performance Guarantee: Security After the Contract Is Won
noun · usually furnished as a "performance bank guarantee" (PBG); also called "performance security"
Definition
A performance guarantee is the security a contractor furnishes after winning a contract, to cover its obligation to carry out the work as agreed.
It is usually given as a bank guarantee, called a performance bank guarantee (PBG). If the contractor fails to perform, the employer can invoke it and recover.
The guarantee at a glance
While biddingEarnest money depositprotects the authority during bidding
After the awardPerformance guaranteeprotects it during delivery
- Given by
- The contractor that won the bid
- Given to
- The employer or awarding authority, before or at signing
- Usually as
- A bank guarantee from the contractor's bank, issued against its bank limit
- Invoked if
- The work is abandoned, done defectively or misses the specification
- Released
- On completion, after any defect period, normally on a written request
What it covers
01What a performance guarantee covers once work is awarded
In a tender, the earnest money deposit protects the authority during bidding. The performance guarantee protects it during delivery. If the contractor abandons the work, performs it defectively or misses the specification, the authority invokes the guarantee.
When a bank speaks of a "performance guarantee", it means the bank's own undertaking to pay the employer on demand under these terms. Because it is issued against the contractor's bank limit rather than paid in cash, each guarantee uses up limit that cannot then be used for working capital.
How it works in a tender or a construction contract
Contract timeline- BidEarnest money deposit lodged with the bid
- AwardThe contractor wins the bid
- Guarantee lodgedBefore or at signing, usually through its bank
- Work and completionThe guarantee stays in force through the contract period
- Defect liability periodLater faults remain the contractor's responsibility
- ReleaseOn completion, and after any defect period
Bid stage securityPerformance guarantee lodged and releasedStages of the contract
The authority invokes the guarantee if the contractor
- abandons the work
- performs it defectively
- misses the specification
Each guarantee uses up bank limit
A contractor winning several contracts in a short time can find the last one hard to fund for that reason alone: every guarantee already issued sits against the same limit that working capital would draw on.
Why standing is rechecked
02Why awarding authorities recheck financial standing at the PBG stage
The two stages answer different questions.
Can it furnish a much larger guarantee?
The performance stage establishes that it can, which needs its bank to extend a limit against the contractor's own standing. So the authority often checks again.
A contractor that wins the bid but cannot obtain the guarantee loses the contract, and usually the bid deposit with it. This is where a certified financial position does real work. The issuing bank reads it before agreeing the limit, and the authority may ask for a solvency certificate again to satisfy itself that nothing has changed since the bid. Months can pass between bid and award, and a contractor whose position has weakened in that time may find the bank unwilling to issue on the terms assumed at bidding.
What the months between bid and award can do
- Time passesMonths can separate the bid from the award.
- The position weakensThe contractor's standing is no longer what the bid showed.
- The bank hesitatesIt will not issue on the terms assumed at bidding.
- The contract is lostAnd usually the bid deposit with it.
A certified financial position is what the bank reads before agreeing the limit, and what the authority may ask for again before it accepts the guarantee. Where it enters the bank's file is set out in Net Worth Certificates for Bank Guarantees, Explained.
Amount and validity
03How contracts set the amount and validity
A proportion of the contract value
Each contract fixes the guarantee amount, usually as a proportion of the contract value. The proportion varies by department and by the nature of the work.
For central government procurement of goods, consultancy and non-consultancy services, the General Financial Rules, 2017 set performance security at three to five per cent of the contract value; for works, performance security together with any security deposit or retention money is three to ten per cent. States and public sector undertakings follow their own rules.
Often well past the end of the work
Validity usually covers the contract period, the defect liability period and a claim period beyond it, so the guarantee can run well past the end of the work.
- Contract period
- Defect liability period
- Claim period
the period the guarantee stays valid
For central government procurement, the General Financial Rules, 2017 require performance security to stay valid for sixty days beyond the date the supplier completes all contractual obligations, including warranty obligations.
A few practical points
- 1The wording is prescribed
Usually by the department, and banks issue it as drafted.
- 2Overruns need an extension
Where the work overruns, an extension is often required, and failing to extend can itself be treated as a default.
- 3Release is rarely automatic
The contractor usually has to ask in writing, with a completion certificate. A guarantee left unreleased keeps tying up bank limit.
Written by Subham Jhunjhunwala · Reviewed by CA Sundram Gupta
This entry describes Indian contract practice in general terms. The contract governs each guarantee.
Need help with a certificate that uses performance guarantee? See our Solvency Certificate.