The Gazette 1986

GAZETTE

JULY/AUGUST 1986

Performance Guarantees

Parti

Gabriel J . McGann, B.A.(Mod), LL.M. (Yale), Barrister-at-law

Introduction

ome commercial contracts include provision for one

party, often the seller, to procure a so-called perfor-

mance guarantee or bond from a bank or an insurance

company in favour of the other contracting party. There

are various types of bond or guarantee, some geared to

default by the principal whilst others are more in the

nature of a primary obligation. Classified according to

the obligations or rights secured, the main types are the

tender (or bid) bond, the performance bond (or

guarantee) and the repayment (or advance payment)

guarantee. The tender bond is a bond to secure that if

the principal's tender is successful he will sign the

contract, failing which the amount of the bond will

become payable to compensate the beneficiary for his

trouble, expense and possible loss in having to contract

with another tenderee or go out to fresh tender. The

performance bond, or guarantee, is given to safeguard

the beneficiary where the principal has signed a contract

and has failed to comply with his contractual

obligations. It is a guarantee of performance. The

repayment guarantee enables the beneficiary, in the

event of the principal's default in payment, to recover

advances or other payments made by him.

Performance guarantees may also be classified

according to the events which trigger the liability of the

guarantor. Thus, whilst the traditional guarantee calls

for the beneficiary to establish default, those benefi-

ciaries who are in a strong bargaining position have

been able to exact "on-demand" or "first demand"

guarantees, which oblige the guarantor to pay on

written demand from the beneficiary, irrespective of

whether there has been default by the principal, and

indeed, in some cases, without obligation even for the

demand to contain a declaration of default. Such

"guarantees" are in law plainly primary undertakings

and are not guarantees in the legal sense. It is important

to note that the various types of bond or guarantee

referred to above may take the traditional or on-

demand form. This article is concerned with perfor-

mance bonds in the on-demand form, i.e., where the

obligation to pay arises on first demand (or on first

demand supported by a specified document) without

any independent evidence of the validity of the claim

(save only to the extent that such evidence may

sometimes be provided by a specified document, e.g.,

an arbitration award).

It has been repeatedly stated that performance

guarantees should be regarded virtually as promissory

notes payable on demand. In

Edward

Owen

Engineering Limited

-v-

Barclays Bank International

Limited,

the detailed facts of which are set out below,

English suppliers agreed to supply and instal glass-

houses and arranged that a performance guarantee be

given to their Libyan customers. Lord Denning M.R.

posed the following hypothetical situation:

"[S]uppose the English supplier had been paid for

the goods and had delivered them, but that the

Libyan customer then discovered that they were

defective and not up to contract, or that they had

been delayed. The Libyan customer could then

claim damages for the breach. But instead of

coming to England to sue for the breach, his

remedy would be to claim payment under the

guarantee — of the 10 per cent, or the 5 per cent,

of the price — as liquidated damage, so to speak."

He continued:

"[I]t is obvious that that course of action can be

followed, not only when there are substantial

breaches of contract, but also when the breaches

are insubstantial or trivial, in which case they

bear the colour of a penalty rather than liquidated

damages: or even when the breaches are merely

allegations by the customer without any proof at

all: or even when the breaches are non-existent.

The performance guarantee then bears the colour

of a discount on the price of 10 per cent, or 5 per

cent, or as the case may be. The customer can

always enforce payment by making a claim on the

guarantee and it will then be passed down the line

to the English supplier. This possibility is so real

that the English supplier, if he is wise, will take it

into account when quoting his price for the

contract."

The doctrine of strict compliance

and the principle of autonomy

The English courts in recent cases and Mr. Justice

Keane in the recent unreported case of

Hibernia Meats

Limited

-v-

Ministere de I'Agriculture

et de la

Revolution Agraire (Office Regional des Viandes de

I'East) and Trinity Bank Limited

have treated such

documents as analogous to letters of credit. O'Higgins

C.J. recently defined a letter of credit as "a form of

documentary credit commonly used in international

trading, particularly in relation to goods being shipped

by a seller in one country to a buyer in another" and

involving "a guarantee to the seller from a bank

acceptable to him that having shipped or delivered the

goods he has contracted to sell he will be paid".

The

law relating to such documentary credits is well settled.

By contrast, a performance bond or guarantee is "a new

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