Performance Bond Workshop - 4 December 2013

Construction Law Training: Performance Bonds4 December 2013

Francis Ho, Head of [email protected] | + 44 20 7067 3000 | @fkyh

1. Introduction to performance bonds

•What is their purpose?

•What parties are involved?

•Contractor (Principal)

•Employer (Beneficiary)

•Issuer (Surety)

•What are the two types?

•Default bonds

•On demand bonds

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2. A brief background: Default bonds

•Origins in early 19th Century

•A guarantee rather than a “true” bond

•Requirement to establish Contractor default

•Primarily to protect against Contractor’s insolvency

•Commonly used on UK construction projects

•Issued mainly by insurance and surety companies


2. A brief background: On demand bonds

•Origins in 1970s; an international creature

•Means of overcoming legal and language difficulties

•Payable on demand so helpful for Employers but risky for Contractor (note Issuer counter-indemnity requirements)

•Commonly used on international construction projects and UK oil and gas projects

•Usually issued by banks


3. When can an Employer draw: Default bonds

• What are circumstances under which Employer entitled to payment?

• Employer must usually establish:

• Contractor’s liability under Construction Contract

• Employer has suffered loss

• How much money Employer has lost

• May require litigation before Employer can claim

• Primarily means of protection against Contractor insolvency


3. When can an Employer draw: On demand bonds

• What are circumstances under which Employer is entitled to payment?

• Payable on first demand

• No requirement to establish Contractor’s default or Employer’s loss


4. How to prevent a call: Default bonds

•Issuer can put Employer to proof

•Issuer’s liabilities are same as Contractor’s so it may be released for any:

•Forbearance given by Employer to Contractor

•Material alternation of Construction Contract without Issuer’s consent

•Employers should consider “indulgence” clause to prevent this

•Expiry date or event relating to bond occurs


4. How to prevent a call: On demand bonds

•Very difficult, even if Contractor can dispute any allegation of non-performance

•Fraud

•Illegality (usually effective depending on governing law of country of enforcement)

•Unconscionability (Singapore)

•Court order/injunction to either (i) restrain Employer from making call or (ii) Issuer from making payment upon receipt of Employer’s notice

•Courts reluctant to intervene in contract relations between parties


5. Drafting and commercial considerations: For Employers

•If bond to be on demand, make this clear in drafting

•Is insolvency a breach of contract?

•Can bond be used to claim liquidated damages?

•Does Issuer have satisfactory financial covenant?

•Is Issuer based in Employer’s home country?


5. Drafting and commercial considerations: For Contractors

•What is the cost? Has it been priced for?

•If Employer’s main concern is Contractor’s insolvency, will default bond suffice?

•Unfair calling insurance and Uniform Rules for Demand Guarantees

•Clause in Construction Contract to allow Contractor to recover overpayment under bond

•Longstop date?

•Risk of “pay or extend”


5. Drafting and commercial considerations: For Issuers

•Is there a longstop date?

•Counter-indemnity with Contractor

•Has Issuer examined the Contractor’s financial position and ability to perform its obligations under the Construction Contract?


6. Further reading

•ABI Model Form Of Guarantee Bond


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Performance Bond Workshop - 4 December 2013