Akeem Lopez
Introduction
Performance or on-demand bonds have been described as the lifeblood of commerce and are a common feature in Requests for Proposals (RFPs) issued by local public bodies and state agencies. A performance bond is a surety given by a third party (usually a bank or insurance company) to guarantee the completion of another’s contractual obligations. The amount payable under a performance bond can sometimes range from 2 to10 per cent of the value of the underlying contract.
The English High Court in a recent decision handed down in Power Projects Sanayi Insaat Ticaret Ltd Sirketi v Star Assurance Company Ltd [2024] EWHC 2798 (Comm) (the ‘Power Projects case’), provided useful guidance on the legal nature of performance bonds and the implications they may have for commercial relationships.
The Power Projects Case
In the Power Projects case, Power Projects was a contractor specialising in the construction of large-scale energy projects. Through a series of subcontracts culminating in two subcontracts entered into in 2019, Power Projects subcontracted the construction of a power-generation plant in Ghana to Glotec Engineering and Glotech Korea (collectively the ‘Glotech companies’).
Under each of the subcontracts, the Glotech companies were required to provide an on-demand performance bond in favour of Power Projects to secure the performance of their respective obligations under the subcontracts.
At the request of the Glotech companies, Star Assurance Company (‘Star’) provided the two bonds. Under the bonds:
* Clause 2, Star undertook to pay to PP within three business days of receipt of written demand from Power Projects in accordance with clause 4 an amount equal to the lesser of the amount specified in the demand or US$6,297,000 less any previous payments made under the bond;
Clause 3, Star’s obligation to make payments under the bond “shall arise upon receipt of a demand made in accordance with provisions of this Bond, without any further proof or condition and without any right of set-off or counterclaim, and [Star] shall not be required or permitted to make any other investigation or enquiry”;
Clause 4, any demand by PP “shall be substantially in the form set out in schedule 1 and shall be delivered to [Star] on a business day and during normal Insurance Companying [sic] hours at its principal office address…”; and
Clauses 1 and 6, the bond was due to expire on 21 November 2021.
Clause 8.5 of each of the subcontracts provided that:
“Failure and or omission of the Subcontractor to proceed in compliance with the present or to perform and or remedy any defects, perform the subcontract works and all obligations, commitments, guarantees and responsibilities under the present and the applicable laws, entitles [the claimant] to make a demand under performance [sic] bond irrespective of any possible objections the subcontractor [sic]-who is expressly consenting to that, and his consensus is only proved by the signature of the present contract.”
Power Projects claimed that there were a number of failures on the part of the Glotech Companies between 2019 and 2021. The Glotech Companies refuted this and claimed that their respective contractual obligations were successfully completed. Star argued that Power Projects was aware of the position of the Glotech Companies and nevertheless proceeded to issue the written demand calling for Star to pay the amount due under the bond.
The focal point of this decision was the determination of a procedural application under the English Civil Proceedings Rules (‘CPR’), which required the judge to consider whether there was a ‘substantial dispute of fact’ for the purposes of moving the proceedings to another Part of the CPR.
In so doing, the judge very helpfully set out the following general principles related to performance bonds:
* Performance/on-demand bonds are to be treated as an autonomous contract, independent of disputes between the relevant parties as to their relative entitlements pursuant to the underlying contract. In other words, liability under the bond is separate from liability under the underlying contract;
* The obligation of the bond issuer is to pay any amount due under the bond once a demand is made or any other such required document is provided in accordance with the terms of the bond. Put another way, the bond issuer’s obligation crystallises upon such demand being made or document being submitted;
* Any disagreement on payment made under a performance/on-demand bond and liability related to the underlying contract is a matter to be resolved by the parties to the underlying contract – not the bond issuer and the beneficiary;
* The sole defence available to a bond issuer against a demand made by a beneficiary is clear fraud of which the bond issuer has notice at the time of the demand. The bond issuer would be required to plead and prove that the beneficiary was dishonest or otherwise had no good-faith belief that the relevant amount under the bond was due. It would not be enough to show that the beneficiary was under a mistaken belief that the demand was a correct demand under the relevant bond; there must be evidence of fraud or dishonesty; and
* To lay claim to the fraud exception, the bond issuer must provide particularly cogent evidence in support of same.
Conclusion
Performance bonds remain a staple in commercial contracts, particularly in the local construction sector and in dealings with public bodies/state agencies. It is incumbent upon parties to such bonds to understand their implications. For bond issuers, if a beneficiary demands payment in accordance with the terms of the bond, the payment obligation crystallises and must be satisfied. A bond issuer is generally not entitled to inquire into the affairs of the parties to the underlying contract. Beneficiaries should also be aware that a demand for payment pursuant to a performance bond can be defeated if the bond issuer can provide cogent evidence of fraud/dishonesty or that the beneficiary otherwise deliberately made a claim which it knew to be invalid or without basis.
Akeem Lopez is an Associate at M. Hamel-Smith & Co. He can be reached at mhs@trinidadlaw.com.
Disclaimer: This column contains general information on legal topics and does not constitute legal advice.
