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News » Law » Performance bond or guarantee: spot the difference » published 4 Feb 2013

Performance bond or guarantee: spot the difference

The distinction between performance bonds and guarantees is not always clear. Mark Clinton reports.

Mark Clinton is a partner of Thomas Eggar LLP Above: Mark Clinton is a partner of Thomas Eggar LLP

It is a sign of the times that performance bonds have become commonplace again on projects. The last thing you want is a dispute over whether you can claim under them when you need to.

The phrase “performance bond” is often misleading. Most construction performance bonds are actually guarantees. Bonds and guarantees are related but they are very different legal instruments. The right to claim under a guarantee is linked to non-performance of the underlying contract. Under a bond, the bank to pay is required to pay on demand regardless of the underlying contract.

Over time, the wording of bonds and guarantees in common circulation has become confused so that they contain a mixture of terms that belong in bonds and terms that apply to guarantees. It has become difficult to tell whether some of them are bonds or guarantees – even for judges.

In the recent case of Wuhan Guoyu Logistic Group Co Ltd and others v Emporiki Bank of Greece SA [2012] EWHC 1715 (Comm) (22 June 2012), the high court weighed up the provisions in the instrument that suggested it was a bond and those that indicated it was a guarantee.

Wuhan (the seller) operated a shipyard. It entered into a shipbuilding contract where the purchase price was paid by instalments.

Emporiki (the bank) provided finance to the buyer and issued the payment guarantee in favour of the seller which was the subject of this litigation. Emporiki agreed to: “irrecoverably, absolutely and unconditionally guarantee, as a primary obligator and not merely as surety, the due and punctual payment by the buyer” and that “upon receipt by us     of your first written demand stating that the [buyer] has been in default of the payment obligation for twenty day, we shall immediately pay to you...”

Did this wording constitute a guarantee or a performance bond?

The court decided that the wording required a default and therefore it was a guarantee. That meant that the bank did not have to pay unless the buyer actually owed money under the contract. The matter then went to the Court of Appeal ([2012 EWHC 1715 (Comm)) which reached the opposite conclusion.

If the following elements are present in your document, there will usually be a presumption that it is an on-demand bond where the instrument:

  • Relates to an underlying transaction between parties in different jurisdictions
  • Is issued by a bank
  • Contains an undertaking to pay “on demand” (with or without the words “first” and/or “written”)
  • Does not contain clauses excluding or limiting the defences available to a guarantor

In Wuhan, the Court of Appeal considered that greater weight should have been given to the presumption of a demand guarantee and therefore the bank was obliged to pay regardless of the position with the underlying contract. So long as the industry continues to use documents like those commonly in circulation, courts will continue to be faced with difficult disputes like that in Wuhan.

This is a difficult area of law. Even when there is no dispute about what the instrument is, arguments about the right to claim arise. Just twelve days after Wuhan, the Court of Appeal had to deal with such a dispute in Aviva Insurance Ltd v Hackney Empire Ltd ([2012] EWCA Civ 1716). This is one for another article. In the meantime, be careful to make sure that you are getting the security you thought you were getting.

 

About the author: Mark Clinton is a partner of Thomas Eggar LLP

 

 

 

 

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This article was published on 4 Feb 2013 (last updated on 4 Feb 2013).

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