Definition
Performance guarantee means the commitment to supply a certain level of service/supplies to satisfy the obligation agreed between the parties. Usually, banks offer performance guarantees to the client on behalf of the contractor/supplier. This guarantee from the bank puts the client in a position to trust the supplier/contract.
There are their stakeholders with different stakes like,
- The contractor – can contract as the bank gives a guarantee on their behalf.
- The client – they get a commitment that their work will be completed within a set time.
- The bank – they charge a fee from contractors/suppliers.
Detailed concept
Big clients and companies require a performance guarantee before entering into the contract with the contractors. These companies want to protect their stake and avoid losses. So, the bank provides a written guarantee to pay the damages if the contractor/supplier fails to perform in line with the contract.
Further, it’s easy for the companies/clients to place reliance on the banks than seeking a direct guarantee from the service provider. It’s equally important to note that banks require a certain deposit from a contractor to issue a performance guarantee on their behalf.
Types of performance guarantee
There are two main types that include advance payment guarantee and the tender guarantee.
Advance payment guarantee is only applicable when contractor/supplier receives a certain amount as advance. It’s the guarantee that the bank will pay the amount to the buyer if there is some dispute between the contractor and the buyer. This guarantee is limited to the amount of advance.
On the other hand, a tender guarantee requires the bank to pay damages to the buyer when the contractor does not comply with specific provisions. The provision may be related to completion time, quality of the service, and other aspects.
Performance guarantee examples
Following are some of the examples of performance guarantees.
- Guarantee issued by a bank on behalf of supplier to ensure 80 tons of wheat to the buyer.
- Guarantee issued by a bank on behalf of the contractor to construct 22 KM road in six months.
- Guarantee issued by the bank on behalf of the service provider to ensure a level of service.
Performance bank guarantee
Performance guarantee by the bank is when a bank is involved in the process. Their stake is to earn revenue, and they charge to the contractor/suppliers. It’s important to note that other financial institutions can also issue performance guarantees.
Performance guarantee insurance
Term performance guarantee insurance is sometimes used to define the performance guarantee. It’s a type of insurance that sighs the buyer regarding the quality/timely completion of the work.
Performance bond vs. performance guarantee
The performance bond is the name of the agreement between the buyer and supplier/contractor. As per provisions of the bond, the supplier will be liable to perform a certain level of service/provide material. On the other hand, a performance guarantee is issued by a bank on behalf of a supplier/contractor.
Financial guarantee vs. performance guarantee
A financial guarantee is when the guarantor assures payment of money in case of default. For instance, the contractor must repay the advance in case they cannot complete the work, or the buyer can claim their money under guarantee.
On the flip side, a performance guarantee assures payment of compensation in case the work is delayed or not in line with the agreed quality level. It’s not a direct claim for the money; it’s a claim for the compensation.
Performance guarantee in construction contracts
Construction contracts usually contain a clause for the performance guarantee. Following are some of the reasons for same.
- These contracts are usually time-bound.
- Disagreements/clashes are common in the final design of the constructed building.
- These contracts include a massive amount.
Conclusion
Following are conclusive remarks.
- The bank issues a performance guarantee on behalf of the supplier/contractor.
- The bank pays the buyer damages if the supplier does not perform in line with the contract.
- Two types of performance guarantee include advance back-up and tender quality.
- A financial guarantee is about assurance to pay money; a performance guarantee is about assurance to compensate.
Frequently asked questions
Why is performance guarantee important?
Performance guarantee is essential from the buyer’s perspective. The buyer wants to be protected from mis-commitment of the supplier/contract, and that’s why they only provide contracts to the suppliers that can arrange performance guarantees.
What are the benefits of a performance guarantee?
Following are some of the benefits associated with the performance guarantee,
- Provides sigh/relief to the buyer of services.
- The bank earns revenue with the issuance .
- It helps the supplier to earn the contract.
What is the financial guarantee?
A financial guarantee is an assurance provided to pay the money in case of default/non-compliance with the provisions of the contract/agreement.
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