Performance Bonds - 11 December 2009


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A presentation given on 11 December 2009 on performance bonds on international construction projects.

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Performance Bonds - 11 December 2009

  1. 1. Session 4 WORKSHOP I: Performance Bonds Francis Ho, Senior Associate Energy & Infrastructure Project Development: e-mail: Legal and Commercial Issues for Major Projects Phone: +971 2 652 3426 London, UK Mobile: +971 50 557 0446 11 December 2009
  2. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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?