A performance bond is a financial guarantee provided by a surety (usually a bank or an insurance company) on behalf of the contractor to the project developer. It is the final bond written when a contractor is awarded a project and the bond guarantees nearly every term and condition in the contract.

A performance bond is commonly viewed as a contract between the contractor (the obliging party or called principal in the bond) and the third party (a guarantor, bondsman, or surety), which is signed and will be void if the related contract is carried out as agreed but shall warrant a release in favor of the owner (the offering party or beneficiary), if the contractor fails to meet the conditions.[i]

In African Insurance Development V. NLNG LTD, Per Ayoola, JSC stated thus;

“Performance bonds are bonds made to secure the performance of a principal contract. Such bonds may be classified according to the obligation undertaken by the obligee. In some cases, it is, in reality, a conditional guarantee, while in others, it may be what is described as an ‘on-demand bond’ or, as it is sometimes called a ‘first demand bond.”[ii]

The bond guarantees the execution of the contract by the surety in the event that the contractor fails to fully perform the contract.[iii] It acts as a protection for the project developer against any potential loss or damages incurred due to the contractor’s failure to meet the agreed-upon performance standards.

It is a common requirement for most major construction contracts, especially for public sector projects, as it provides reassurance to the project developer that the contractor can fulfill its contractual obligations.[iv] It is usually invoked when a contractor defaults or fails to deliver the completed project as agreed, then the project developer can make a claim on the bond to recover any losses incurred in the project.

In Nigeria, performance bonds play a crucial role in project finance contracts by providing a financial guarantee that ensures project obligations are met. They can significantly impact contract disputes in the following ways:

1. Risk Mitigation: Performance bonds reduce the risk for project owners by ensuring that if a contractor fails to meet their obligations, the bond can be called upon to cover the costs of completing the project or remedying the deficiencies. This can prevent disputes over financial losses and project delays.

2. Dispute Resolution: Having a performance bond in place can sometimes streamline dispute resolution. Since the bond provides a clear financial remedy, it can expedite negotiations or legal processes, reducing the need for prolonged litigation.
3.  Contract Compliance: The existence of a performance bond encourages contractors to comply with contractual terms, as non-compliance could result in the bond being forfeited. This can help prevent disputes arising from non-performance or substandard work.
4. Legal Framework: The legal framework governing performance bonds in Nigeria, including regulations and enforcement practices, can influence the nature and frequency of disputes. Effective legal recourse and clear guidelines can help in resolving disputes more efficiently.

Overall, performance bonds are intended to provide a safeguard against default and can play a significant role in managing and mitigating disputes in project finance contracts in Nigeria.

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[i] https://www.researchgate.net/publication/323674455_The_problems_and_abuse_of_performance_bond_in_the_construction_Industry

[ii] (2002) LPELR-210(SC)

[iii] https://www.researchgate.net/publication/336192909_Assessment_of_bonds_utilisation_in_the_Nigerian_construction_industry

[iv] https://harperjames.co.uk/article/performance-bonds-construction/

Written by Vera Enubianozor for The Trusted Advisors

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