On-demand bonds in construction
Bonds are a means of protection against the non-performance of the contractor. They are an undertaking by a bondsman or surety to make a payment to the client in the event of non-performance of the contractor. The cost of the bond is usually borne by the contractor, albeit, this is likely to be reflected in the contractor's tender price.
Bonds can be 'on demand' or 'conditional', with conditional bonds requiring that the client provides evidence that the contractor has not performed their obligations under the contract and that they have suffered a loss as a consequence.
With on-demand bonds, the bondsman pays an amount of money set out in the bond immediately on demand in writing without needing to satisfy any preconditions whatsoever (including establishing the contractor’s liability) unless the demand is fraudulent. On-demand bonds tend to be common in international projects but are less normal in the UK were they are generally resisted because of their draconian nature.
Types of bonds that are may be on-demand bonds include:
- Advance payment bonds.
- Off-site materials bonds.
- Bid bonds (or tender bonds).
- Defects liability bonds.
It is important to bear in mind that the name of the document can be misleading and does not necessarily accurately describe the nature of document. It is the content of the document that is key.
In the case of Wuhan Guoyu Logistics Group Co Ltd & Anr v Emporiki Bank of Greece SA (2013) the buyer agreed to provide a payment guarantee from its bank, Emporiki Bank, to Wuhan (the seller), which guaranteed certain of the buyer’s payment obligations under a shipbuilding contract. An earlier court judgment found that the payment guarantee was actually an on-demand bond. The seller demanded payment of an unpaid instalment from the buyer who refused to pay believing the instalment was not due. Consequently, the seller made a demand, in good faith, under the bond from the defendant for the unpaid instalment of the contract price. The defendant paid the money but a subsequent arbitration found that the instalment was not in fact due so the defendant argued that because of the mistake, the monies paid under the bond should be held on trust for it.
The Court of Appeal rejected the defendant’s submissions finding that the bond was an autonomous contract, independent of the contract between the buyer and seller, so that when the seller made a call under the bond, monies were immediately payable as an enforceable cause of action had accrued against the defendant pursuant to the terms of the bond.
If it is at all possible to avoid giving such bonds, they should be resisted where alternative security is available.
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