REUTERS | Navesh Chitrakar

Performance bonds: check your expiry dates

The recent TCC case of Simon Carves Ltd v Ensus UK Ltd underlines the importance of knowing how and when any performance security expires.

A party can be prevented from seeking payment under a bond by the terms of the very contract in respect of which the bond was provided

The parties entered into an IChemE Red Book contract, and the contractor provided an on-demand performance bond in favour of the employer. The bond was stated to become “null and void (save in respect of any pending or previously notified claims)” when the Acceptance Certificate was issued.

The Acceptance Certificate was duly issued. It included a long list of defects, some of which related to emissions from the plant. (The employer had already raised the emissions problem in earlier defects notices.) The contractor argued that these communications about defects were not “claims” under the contract, so the performance bond was null and void. It sought an injunction preventing the bond being called.

The employer could be excused for thinking that its defects notices and the list of defects included in the Acceptance Certificate constituted “pending or previously notified claims” for the purposes of the performance bond. However, Akenhead J considered that it was commercially sensible (particularly given the impact of claims upon the bond in question) that a party making a claim must make this clear to the other party. He therefore granted the injunction and, in these proceedings, held that it should continue.

He based this decision on the fact that the contract provided (in clause 19.5) that:

“[a]ny claim made by either party under the Contract… shall be supported by a written statement of grounds and a summary of material facts upon which it is based.”

This decision may seem a little surprising, given that the employer had previously given clear notice of the defects. However, the employer faced another problem. In correspondence it had referred to “submitting a claim in accordance with clause 19.5”, but had not in fact done so. On any interpretation (and in absence of any evidence to the contrary) a formal “claim” had not been previously notified.

The general rule and the fraud exception

As a general rule, the courts rarely intervene to restrain calls being made or honoured under bonds of this nature. However, the courts will intervene if there is very clear evidence of fraud that justifies an injunction.

Absent fraud, a court will not restrain a beneficiary from claiming under an on-demand bond just because it is in dispute with its contractual counterparty as to whether that party is in breach of the underlying contract. To do otherwise would damage trust in international commerce. This is still true, as far as it goes.

What effect does this case have on the ability to call on a bond and the perceived value of bonds?

The particular issue that arose in this case is rare. Akenhead J recognised that calling a bond when the beneficiary knows (or can be taken to know) that the underlying contract forbids it from doing so is arguably a type of fraud. However, in his view it represented a second exception to the general rule.

Whether it is a type of fraud or a second exception, it seems right to me that a beneficiary of an on-demand bond should be restrained from making a claim under the bond in circumstances where the underlying contract expressly prevents it from doing so.

The underlying disputes between the parties in this case are still to be resolved, but it may prove to be an unfortunate example of how easy it is for an employer to unwittingly allow a bond, guarantee or letter of credit to expire just when its protection is most needed. However, it should not be regarded as affecting the ability to call on an on-demand bond in the normal course, nor affect the value of this type of performance security.

Beneficiaries: make sure that your performance security expires at the appropriate time for the project in question. Under the IChemE Red Book, it may have been more appropriate for the bond to expire when all the defects had been rectified, rather than when the performance tests had been completed.

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