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Performance Bonds - 11 December 2009
1. Session 4
WORKSHOP I:
Performance Bonds
Francis Ho, Senior Associate Energy & Infrastructure Project Development:
e-mail: fho@kslaw.com Legal and Commercial Issues for Major Projects
Phone: +971 2 652 3426 London, UK
Mobile: +971 50 557 0446 11 December 2009
2. Performance Bonds - Introduction
What is their purpose?
Parties involved:
(1) Contractor (Principal)
(2) Employer (Beneficiary)
(3) Issuer (Surety)
Two main types:
(1) Default bonds
(2) On demand bonds
3. (1) Default Bonds - Background
Originated in early 19th Century
Guarantee rather than “true” bond
Requirement to establish Contractor default
Primarily protect against Contractor insolvency
Commonly used on projects in the UK
Mostly issued by insurance and surety
companies
4. Default Bonds – When can Employer draw?
What are circumstances under which Employer
entitled to payment?
Employer must usually establish:
Contractor’s liability under Contract
Employer has suffered loss
May require litigation before can claim
Primarily protection against insolvency
5. (2) On demand Bonds - background
International - originated in 1970s
Means of overcoming legal and language
difficulties
Payable on demand so good for employers
and risky for contractors (especially as there
will be counter-indemnity to Issuer)
Commonly used on international projects
and some UK power and oil projects
Usually issued by banks
6. On demand Bonds – When can Employer
draw?
What are circumstances under which Employer
entitled to payment?
Payable on first demand
No requirement to establish Contractor default
or Employer loss
7. Default Bonds - How can a call be prevented?
Issuer can put Employer to proof
Issuer’s obligations same as Contractor’s,
therefore Issuer’s liability may be released for:
Forbearance given by Employer to
Contractor
Material alteration of Contract without
Issuer’s consent
Consider including “indulgence” clause to
prevent this
Expiry event/date occurs
8. On demand Bonds - How can a call be
prevented?
Very difficult, even if Contractor disputes allegation of
non-performance
Fraud
Illegal under governing law in the country of
enforcement to allow the call (consider governing law)
Lack of good faith (“unconscionability”) - Singapore
Court order or injunction to restrain Employer from call
or Issuer from making payment on receipt
Courts generally reluctant to interfere in contract
relations between commercial parties
9. Drafting and Commercial Considerations (1)
For Employers:
If bond to be on demand, make this clear in
drafting
Can bond be used to claim liquidated damages?
Does Issuer have satisfactory financial
covenant?
Is Issuer based in Employer’s home country? Will
help avoid possible legal uncertainties
10. Drafting and Commercial Considerations (2)
For Contractors:
What is cost? Has bond 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 Contract to allow Contractor to recover for
overpayment under Bond?
Is there longstop date?
Risk of “pay or extend”
11. Drafting and Commercial Considerations (3)
For Issuers:
Is there longstop date?
Counter-indemnity with Contractor
Have they investigated Contractor’s financial
position and ability to perform its Contract
obligations?