On-Demand Bond

Tuesday, September 4th, 2012

On-Demand Bond

An on-demand bond is also referred to as an Unconditional Bond. Contractor’s performance bonds come in two basic varieties to meet the needs of different project owners. An on-demand bond results in an automatic cash payment if the contractor fails to complete the project. With a conditional performance bond the burden of proof lies with the owner or developer. This briefing paper concentrates upon the on-demand bond.

In the Vossloh Case [2010] EWHC 2443 (Ch) the judge explained the “performance bond” in the following way: This brings me to the so-called “performance bond”, sometimes known as a “performance guarantee”, often as a “demand bond” or “demand guarantee” or even as a “first demand guarantee”. In the context of the present dispute I prefer the expression “demand bond”. In essence it is a particularly stringent contract of indemnity. It is a contractual undertaking by a person, usually a bank, to pay a specified amount of money to a third party on the occurrence of a stated event, usually the non-fulfilment of a contractual obligation by the principal to that third party. Sometimes the wording of the contract has the result that the liability of the person who has given the bond arises on mere demand by the creditor notwithstanding that it may be evident that the principal is not in any way in default or even that the creditor himself is in default under his contract with the principal. It all depends on the wording of the instrument. It is often a difficult question to determine whether, on its true construction, a particular contract which provides for payment on demand is a performance or demand bond (where the obligation to pay is triggered by a demand alone or by a demand accompanied by the provision of specified documents) or whether it is a guarantee (strictly so called) where the obligation to pay is of the “see to it” kind, i.e. conditional on proof by the creditor of default of the principal.”

The courts will usually only block payment under an on-demand bond in the case of established or obvious fraud. However, in the case of Simon Carves Ltd v Ensus UK Ltd [2011] EWHC 657, the Court added another ground on which to restrain performance. The written contract incorporated the General Conditions of Contract for Lump Sum Contracts published by the Institution of Chemical Engineers in 2001, known as the Red Book. The contract said that as soon as the plant has passed all the performance tests, the Purchaser’s project manager shall issue the Acceptance Certificate. Some of the Special Conditions related to the Bond, namely:

–          The Performance Bond shall be provided as security for any and all of the Contractor’s obligations and liabilities under the Contract

–          The Performance Bond shall initially be for an amount equivalent to 12% of the Contract Price

–          Upon the issue of the Acceptance Certificate the Performance Bond shall become null and void (save in respect of any pending or previously notified claims)

It can be noted that Simon Carves procured a Performance Bond from Standard Chartered Bank in the due amount of £18,480,000. The on-demand wording said “The Bank’s obligation to make payments under this Bond shall arise on receipt of a demand made in accordance with the provisions of this Bond without any further proof or condition and without any right of set-off or counterclaim and the Bank shall not be required or permitted to make any other investigation or enquiry.”

As with all cases in the High Court there are complex issues in this instance, however, an Acceptance Certificate was issued on 19 August 2010. It included the words, “the Plant is accepted subject to outstanding defects being rectified as per the attached schedule and subject to resolution of liability of certain of the rectification works……”

On the 25 February 2011 Simon Carves sought an injunction to restrain Ensus from making any demand under the Bond. The injunction was granted on the 25 February 2011. In this case the judge found that, “The balance of convenience favours the continuing of the injunction in my view.”

There are occasions when Contractors cannot obtain a Performance Bond ad buyers may note that in the Simon Carves case judgment at para 40 it says, “The banks providing the bonds will usually have security and counter-indemnities so that they are secured when and if they have to pay out on the bond to the beneficiaries. It is often the case that banks will not provide more than a certain number of bonds or bonds beyond a certain value to any one contractor (our emphasis).

Our readers should now be convinced that the specialised area of bonds should be actively researched prior to including them in a contract. This briefing paper does not offer legal advice. You should seek formal legal advice from your organisation’s in-house legal services team or, when used, your external legal advisers. When negotiations become necessary on the wording of the document, legal advice and presence is strongly advised.

Next we will cover Conditional Bonds.