Performance Bank Guarantee: Cost, Margin Money, and How to Get It Released

A performance bank guarantee is the largest single piece of working capital a government contract takes out of a small firm, and it stays out for longer than anyone plans for. Understanding what it costs, not what its face value is, is what makes a contract's margin real.

What it secures

A PBG is the buyer's security against your failing to perform the contract. Where a contractor abandons work, or work is defective and not made good, the buyer can invoke the guarantee and the bank pays.

It is furnished after award and before the agreement is executed. It is separate from EMD, which secures the bid, and separate from retention money, which is deducted from running bills.

Most contractors end up carrying all three at once on an active contract, which is why the total capital committed to a job is considerably more than the mobilisation cost.

How much, and for how long

The amount is stated in the contract as a percentage of the contract value. The percentage varies by department and by contract type, and larger or riskier works generally carry more.

The duration is where it gets expensive. A guarantee is normally required to remain valid through the contract period plus the defect liability period, plus a claim period after that. For a works contract with a twelve-month defect liability period, a guarantee furnished at award may need to stay live for well over two years.

That duration, not the percentage, is what makes a PBG costly.

What the bank actually charges

Two separate costs, and bidders routinely price only the first:

Commission, charged by the bank as a percentage per annum or per quarter on the guarantee amount. This is a real cash cost, and it accrues for the whole life of the guarantee.

Margin money, a deposit the bank holds against the guarantee, typically a percentage of the face value, often held as a lien-marked fixed deposit. This is not a fee, but it is capital you cannot use for as long as the guarantee lives.

The margin money is the part that constrains growth. A firm with several live contracts can have a large share of its liquidity lien-marked against guarantees for work that finished a year ago.

Getting it released

This is the step firms most often leave undone, and it is pure money.

The guarantee does not release itself when the defect liability period ends. Someone has to ask. The sequence:

1. Confirm the defect liability period has expired and that no defect notices are outstanding.
2. Write to the buyer requesting release, quoting the contract, the guarantee number, the issuing bank and the expiry.
3. Obtain the buyer's written confirmation that the guarantee is released and returned.
4. Take that to the bank and get the margin money lien lifted.

Step four is the one that returns the cash, and it does not happen without step three.

The pattern to avoid: a guarantee that expired eighteen months ago, never formally released, with margin money still lien-marked, on a contract everyone considers finished. The bank has no reason to release a lien nobody has asked them to release.

Where an expired guarantee bites

The consequence is not just idle cash. Margin money against dead guarantees reduces the limits your bank will extend for new guarantees, which reduces the number of contracts you can hold at once. Firms hit a ceiling on growth that looks like a bank relationship problem and is actually an administrative one.

Alternatives to a bank guarantee

Where the contract permits, an insurance surety bond can substitute, with a different cost structure and generally without the margin money lien. Whether it is cheaper depends on the premium against the commission and the opportunity cost of the locked deposit.

Bank guarantee, FDR or insurance surety bond works through the comparison.

Building it into the price

A PBG's cost belongs in the rate, and it is one of the financing costs most commonly left out:

• Commission, for the full expected life including the defect liability period
• The opportunity cost of margin money over the same period
• The administrative cost of obtaining and releasing it

Together with retention money and the running bill cycle, these make up the financing cost of a government contract, and they are the costs that most often turn a nominal margin into a real loss. How to price a government tender puts them together.

Avsar keeps every live guarantee with its expiry, its margin money and its release status, and flags the ones whose defect liability period has ended so the capital can be recovered. See the treasury module.