The performance bond: how the seller's side is secured
A trade has two promises that must hold at once. The letter of credit secures the buyer's. The performance bond secures the seller's. Here is how it works.
By Hugo Amanajás
A physical trade has two promises that have to hold at the same time. The buyer promises to pay, and the seller promises to perform. The letter of credit secures the first. The performance bond secures the second. Understanding how the bond works is understanding why, once a deal is properly structured, neither side is exposed to the other's failure.
What the bond is, and what it is not
A performance bond, in our structures usually around two per cent of the contract value, is a bank guarantee the seller issues in the buyer's favour after the buyer's payment instrument is operative. It is not a payment. It is a promise the bank will honour if the seller fails to perform as contracted, for example by not shipping conforming goods within the window. If the seller performs, the bond simply expires unused.
Why it comes after the instrument
Sequence matters here as much as anywhere. The seller issues the bond only after the buyer's DLC or SBLC is operative. That order is deliberate. It means neither side hands over a guarantee before the other has committed one of equivalent weight. The buyer's payment is secured by the bank the moment the credit is operative, and the seller's performance is secured by the bond the moment it issues. From that point both obligations are backed by banks, not by trust.
How a bond is called
A performance bond is called against its terms, which are written into the contract. If the seller fails in the way the bond covers, the buyer presents the required documents to the bank and the bond pays. Like the letter of credit, it operates on documents and defined conditions, not on a general sense that something went wrong. That precision protects both sides: the seller cannot be called on a whim, and the buyer is not left without recourse.
/ Two per cent is meant to be small
The bond is not there to compensate a total loss; the inspection and the payment structure prevent that. It is there to give the seller real skin in the game, so that walking away from a signed contract costs money. Paired with the buyer's operative credit, it makes non-performance expensive for whichever side considers it.
The full documentary procedure referenced here is published on our Procedures page.
View Procedures/ About the author
Hugo Amanajás
Hugo Amanajás is an engineer and commodities broker, and the founder of Juros e Bolsa, a CVM-authorised investment advisory in Brazil. He works on the origination and structuring of Brazilian commodities and writes Duna Trading's Insights on how the physical trade actually works, from documentary procedure to compliance.
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