The Gazette 1986

GAZETTE

JULY/AUGUST 1986

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

Introduction 1 S 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, 2 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." "[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." He continued: 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 3 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". 4 The law relating to such documentary credits is well settled. By contrast, a performance bond or guarantee is "a new The doctrine of strict compliance and the principle of autonomy

169