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The Guide to Construction Arbitration

Bonds and Guarantees

Purpose of security

Security in the form of bonds and guarantees is a well-established feature of construction projects.

Bonds or guarantees are, with limited exceptions, sought by the employer to secure the contractor's performance, and to protect advance payments made for mobilisation of the contractor to site, and/or the purchase of long-lead or high-value components or materials. In addition, on-demand bonds or guarantees are regularly used in the construction industry to enable the early release of retention monies. Less frequently, the contractor may also require security to ensure there will be sufficient funds available for an impecunious employer to make payments as and when they fall due, or to protect against regime change when working for public entities in potentially unstable jurisdictions.

Types of security

Before considering the different forms of security typically given in international construction projects, it is important to note that there are essentially two different types of obligations encompassed by such securities, each with different requirements and consequences. In particular, the security provided may impose on the issuer:

  • an autonomous contractual obligation to pay a specified sum of money on the occurrence of a specified event or presentation of a particular document; or
  • an accessory obligation to be answerable in the event that a third party fails to perform a contractual obligation or make a payment owed to the beneficiary under the underlying contract.

Terminology

Unfortunately, there is little consistency in the terminology applied to bonds and guarantees, which causes some confusion and makes it difficult to determine whether a particular security encompasses an autonomous or accessory obligation merely by looking at its title.

Generally speaking, security instruments imposing autonomous obligations tend to be referred to as on-demand bonds or guarantees, first-demand bonds or guarantees, demand bonds or guarantees or standby letters of credit, whereas security instruments imposing accessory obligations are often labelled guarantees, default bonds or surety bonds.

The greatest confusion in the construction sector probably arises from the fact that where these instruments are used as performance security, both types (representing autonomous and accessory obligations) are often labelled as performance bonds or performance guarantees. The situation is not assisted by the fact that, while standard forms are available, they are rarely used in practice, with most employers and issuers of security insisting on their own bespoke wording.

Whether a particular instrument is treated as imposing a autonomous or accessory obligation is a matter of construction of the instrument in question and not dependent on the label attached by the parties.[1] In light of the different legal characteristics of the two, and the consequences that flow therefrom (as set out further below), the question of the proper construction of such security instruments frequently gives rise to litigation or arbitration and is the subject of numerous reported decisions of the English courts.[2]

In this chapter, autonomous contractual obligations will be referred to as ‘on-demand bonds' or ‘on-demand guarantees' and accessory contractual obligations will be referred to as ‘conditional guarantees'.

As will be seen below, the distinction between autonomous and accessory obligations is of fundamental importance. The key difference is that an on-demand bond or guarantee is (subject to intervention by the local courts as discussed below) payable against documents, whereas a claim under a conditional guarantee requires proof that there was a breach of the underlying construction contract.

Autonomous obligations - on-demand bonds and guarantees

The most common forms of security used on international construction projects are on-demand bonds and guarantees. An on-demand bond or guarantee usually stipulates on the face of the bond or guarantee itself what document will have to be to receive payment presented to the issuer in order to receive payment. All that the beneficiary will have to do is issue a demand in accordance with the terms of the bond/guarantee and present the required documents.

The documents required vary from case to case. The most common forms of on-demand bonds and guarantees simply require the employer to demand payment, combined with a formal declaration from the employer that the contractor has failed to perform its obligation under the construction contract.[3] In practice, it is not unusual in the construction industry for on-demand bonds or guarantees to include a pro forma demand letter that the parties negotiate as part of the negotiation of the construction contract and security itself. Additional requirements may include (1) a statement from a specified person that the contractor is in breach of its obligations (for example, the relevant minister or attorney general for public works contracts);[4] or (2) a certificate from a third party (for example, the engineer or the dispute adjudication board). Less common requirements can include provision of an arbitration award or judgment in respect of the underlying construction contract.

The employer beneficiary of such an on-demand bond or guarantee will generally seek to obtain security with the least onerous documentation requirements, such as, for example, a simple demand or certificate issued by the employer, whereas the contractor will seek the additional protection provided by a third party certificate or judgment. Ultimately, the terms of the security will depend on the parties' respective bargaining positions and/or what terms the available issuers[5] are prepared to accept.

Theoretically, when the issuer of the security receives a demand for payment, it simply checks that the demand and supporting documents comply with the terms of the security and, if so, makes payment to the employer. Again, theoretically, the issuing bank is not concerned with the question whether there has in fact been a default by the contractor under the underlying construction contract, which renders the payment due.

In Edward Owen Engineering Ltd v. Barclays Bank International Ltd, Lord Denning MR observed:[6]

All this leads to the conclusion that the performance guarantee stands on a similar footing to a letter of credit. A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relation between the supplier and the customer; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions. The only exception is where there is a clear case of fraud of which the bank has notice.

In practice, depending on the commercial relationship between the issuer of the security and the contractor (or the counter guarantor as the case may be),[7] the issuer may notify the contractor (or the counter guarantor) upon receipt of a demand before making payment. The issuer will do so for one of two reasons: (1) if the issuer is concerned that it may not be able to enforce the security it is holding in relation to the bond/guarantee; or (2) to give the contractor the opportunity to make direct payment and avoid an act of default under the terms of the agreement between the contractor and the issuer.[8]

Where a contractor fears that the employer is about to make a demand, or where the contractor has been informed that a demand has been made by the issuer, the contractor may attempt to block the demand by a court injunction.[9] As noted above, the traditional approach of the English courts was to limit injunctions to situations where there was clear evidence of fraud. This approach has to some extent relaxed in recent years both in England and elsewhere.[10]

In Simon Carves Limited v. Ensus UK Limited the English Technology and Construction Court had to consider the extent to which the terms of the construction contract pursuant to which the performance security had been issued might prevent the employer from seeking payment under the security.[11] In Simon Carves, the underlying construction contract provided that the security would be ‘null and void' and was to be returned to the contractor immediately once the acceptance certificate was issued save in respect of pending claims. The acceptance certificate was issued, albeit with a list of defects attached; one month later the employer issued a defects notice under the mechanism for notifying defects during the defects liability period. The judge, after reviewing a long line of decisions, held that: ‘fraud is not the only ground upon which a call on the bond can be restrained by injunction' and that ‘if the underlying contract, in relation to which the bond has been provided by way of security, clearly and expressly prevents the beneficiary party to the contract from making a demand under the bond, it can be restrained by the Court from making a demand under the bond.' The judge found that the security was null and void under the terms of the construction contract as between the employer and the contractor, and injuncted the employer from making a demand under the bond.[12]

The judge also provided a useful explanation as to the extent to which the commercial consequences of a call on an on-demand bond or guarantee are relevant when an English court is deciding whether to grant an injunction or not:

40. It is well known that bonds are regularly called for on substantial and public procurement projects. These bonds can be conditional bonds or as in this case, unconditional or on-demand bonds. Contractors are required to provide them from an acceptable bank or surety. The banks are not uncommonly the main banks which fund the contractors (albeit that it is not clear that this was the case here); the banks providing the bonds will usually have security and counter-indemnities so that they are secured when and if they have to pay out on the bond to the beneficiaries. It is often the case that banks will not provide more than a certain number of bonds or bonds beyond a certain value to any one contractor. If a bond is called, it may be difficult for the contractor to have that bank provide another equivalent bond for another job at that time.

41. I have formed the view that damages would not be an adequate remedy. My reasons are the same as set out in my earlier judgements on this matter which I will not again set out in detail. Broadly, they are that the calling of the bond as in this case gives rise to a very real risk of damage to the commercial reputation, standing and creditworthiness of [the Contractor] which would be very difficult to quantify; there would be a very real risk that [the Contractor] would not pre-qualify for tenders because often tenderers have to disclose whether there have been recent calls on the bonds and if so on what grounds. There was evidence that there had been an earlier call on the bond but I attach little importance to that in commercial terms because the unchallenged evidence is that it was done by agreement to secure speedy payment; in those circumstances, the call could be readily explained. An added factor is that if, as I have held, [the Contractor] does have a strong case on the continuing validity of the bond as between it and [the Employer], the commercial advantage of not having the bond actually called or the loss of that advantage is unquantifiable. [13]

The English Technology and Construction Court reached a similar conclusion in Doosan Babcock v. Mabe.[14] In Doosan Babcock, the employer had commenced commercial production of electricity from a power plant for which Doosan Babcock had provided two boilers. The on-demand guarantees provided by Doosan Babcock expired on their terms on the earlier of a specified date or the issue of a taking-over certificate. The employer did not issue a taking-over certificate, relying on a contractual provision that permitted use of the boilers without the issuance of the taking-over certificate as a temporary measure. The judge granted an injunction preventing the guarantees being called, finding that there was a strong likelihood that Doosan Babcock would be able to demonstrate that the use of the boilers was not temporary, or that the employer was in breach of the underlying supply contract in not issuing the taking-over certificate.

Accessory obligations - conditional guarantees

A less common form of security in the construction context is the conditional guarantee. By contrast to the autonomous obligations found in on-demand bonds and guarantees, in order to make a claim under a conditional guarantee, the employer will first have to prove that the contractor has in fact failed to perform his or her obligations under the construction contract, and thereby caused the employer loss.

Accordingly, claiming under a conditional guarantee is no less complicated or cumbersome than suing the contractor himself. It will require a detailed factual investigation to prove that the contractor is liable under the construction contract, and may well result in arbitration or litigation proceedings.

If the employer brings a claim under the guarantee, the guarantor will be able to rely on all the defences available to the contractor under the construction contract. Accordingly, the contract of guarantee cannot be viewed in isolation, but must be considered together with the underlying construction contract. To that extent, the liability of the guarantor and the liability of the contractor are co-extensive.

In addition, and to the extent not otherwise provided by the guarantee itself, the general law of suretyship[15] provides additional protection, and possible defences to the guarantor such that the guarantor will be released from liability if there have been any material changes to the terms of the underlying construction contract without his or her consent[16] or where the employer has given additional time to the contractor to perform.[17]

Consequently, it is in most cases considerably more difficult and takes considerably more time for an employer to obtain payment under a conditional guarantee than under an on-demand bond or guarantee and, as a consequence, these instruments perform different functions. Whereas an on-demand bond or guarantee protects the employer's cash flow and enables him or her to obtain payment on account of his or her loss without delay, the main advantage of a conditional guarantee is that it offers a second source of payment if the contractor is insolvent or does not have sufficient monies to sums awarded in respect of his or her failure to perform. In the authors' experience, save for parent company guarantees (which often take the form of a conditional guarantee), it is now more usual for major international contractors to provide on-demand guarantees; conditional guarantees are becoming the exception.

Procuring the security

In the construction industry, security tends to be provided (in ascending order of cost to the contractor) by group companies, banks, and specialist surety or insurance companies:

  • Guarantees from the parent company or another group company of the party to the original construction contract are the least expensive form of security for the contractor (subject, of course, to the cost to the group if the security is called by the employer);
  • Guarantees or bonds issued by a bank. These tend to be ‘on-demand' instruments, as banks are generally reluctant to become involved in investigating or assessing the merits of demands or dispute. The underlying construction contract will often specify what bank (or banks) will be acceptable to the employer, for example, specifying the required location and credit rating of the issuing bank.
  • Guarantees or bonds issued by specialist surety or insurance companies, who will carry out a risk assessment before deciding to underwrite the contractor's obligations, charging a premium for this service.
  • Standby letters of credit issued by banks. These are very similar to on-demand bonds and share the key characteristic that they are payable against documents (rather than proof of liability) and impose an autonomous obligation on the bank independent of the underlying transaction. Standby letters of credit are not frequently used in the construction industry; they are sometimes used to secure delivery of key components where significant up-front payments are required, or as a mechanism for making (and securing) payment where the employer is a government in an unstable jurisdiction.[18]

With the exception of parent company guarantees, when procuring a bond or guarantee, the contractor will need to pay an issuing fee, with further fees payable whenever the bond or guarantee is extended in duration or value. Many international contractors increasingly enter into facility agreements with their bank, pursuant to which the bank will provide a number of commercial banking services, including the provision of bonds and guarantees. The alternative is for the contractor to enter into an ad hoc arrangement with its bank or a commercial provider of bonds and guarantees on a project-by-project basis. In both cases, the contractor will typically have to commit that all sums paid to the contractor under the construction contract will be paid into a specified bank account located at the issuing bank who ultimately bears the risk on the guarantee or bond.[19] In addition, the contractor will have to provide security to the value of the bonds and guarantees. A combination of blocked funds in cash accounts and security over the contractor's fixed and floating assets is typical. The need to provide security in relation to the value of the bonds and guarantees limits the amount of bonds and guarantees that a contractor can procure at any given time.

While it is generally cheaper for the contractor to procure bonds and guarantees under a facility agreement than on an ad hoc basis, the consequence of a demand being made on security procured under a facility agreement can be catastrophic for the contractor. Most facility agreements contain default clauses, whereby a call on an on-demand bond or guarantee constitutes an act of default under the facility agreement unless the contractor is able to make immediate direct payment of the sums demanded to the bank. An act of default may entitle the bank to call in all loans, lines of credit and security provided under the facility agreement whether related to this construction contract or otherwise. Further, cross-default provisions are increasingly common in facility agreements, whereby an act of default under one facility agreement constitutes an act of default under other facility agreements, including facility agreements made with other banks. In short, making a demand on an on-demand guarantee or bond may result in the contractor being unable to continue trading.[20] For this reason, calling an on-demand guarantee or bond tends to be the action of last resort for an employer. 

In an international context the employer will typically require that the contractor procures an on-demand bond or guarantee from a bank in the employer's home country. This arrangement is advantageous for the employer, who can recover monies quickly in their home country without first having to issue proceedings against the contractor in another jurisdiction, or having to pursue a foreign bank to enforce a demand for payment under the guarantee or bond. Unless an international contractor has a significant presence in the foreign jurisdiction, the contractor will not normally have the commercial relationship in place, or available security, to procure a guarantee or bond from a local bank directly. The normal arrangement is for a chain of back-to-back guarantees and counter guarantees to be set up through a series of SWIFT messages,[21] linking the local bank who issues the guarantee to the employer to a bank in the contractor's home jurisdiction who has the commercial relationship with the contractor. Where a demand is made by the employer, the demand will be passed up the chain; the bank in the contractor's home jurisdiction who has the direct relationship with the contractor will provide the funds, which are then fed back down the chain to the employer. 

In most situations, the flow of funds from counter guarantor to guarantor is seamless. The chain of guarantees and counter guarantees may be broken if the international community places the employer under sanctions prohibiting the passing of financial benefit to the employer. While the local bank may not be subject to these sanctions, the international banks who have provided counter-guarantees may be prohibited permanently from honouring the counter-guarantees.[22] In practice, this may result in the local bank (or a bank somewhere in the chain) defaulting on the security.

Forms of security required on international construction projects

The most common forms of guarantees or bonds required on international constructions projects are set out below.

Tender security or bid bonds

Where a large contract is put out to tender, the employer will spend considerable time and money in choosing a suitable contractor. If the prospective contractor withdraws prior to entering into a binding contract or refuses to accept the award of the contract or fails to procure the performance bond required to support the contract, the employer may have to re-open the tender process, incurring substantial delay and additional expense. Accordingly, invitations to tender will often require tenderers to submit a bid bond or tender guarantee for a specified sum. The bond will be released if the tenderer is not selected, or once the tenderer has entered into the construction contract and provided the required performance bond. A bid bond will almost invariably take the form of an on-demand bond or guarantees.[23]

Advance payment guarantees or bonds

In many construction projects the employer will make advance payments to the contractor providing some immediate finance to mobilise to site, purchase materials, or otherwise prepare for the construction works. In exchange, the contractor will often be asked to procure a bond or guarantee to secure the repayment of the advanced funds in the event that the contractor becomes insolvent or fails to perform the contract. The advance is typically ‘clawed back' by the employer through deductions from the interim payments made to the contractor, with the value of the security reduced in parallel.

Performance bonds

The purpose of performance bonds or guarantees is to protect the employer from a failure by the contractor to perform the construction contract. If the contractor acts in breach of contract, the employer is likely to suffer loss (e.g., in the form of delay or through having to order replacement works) and the issuer of the bond or guarantee undertakes to pay the employer a sum of money to compensate him or her for this loss. Even though the purpose of a performance bond or guarantee is frequently described as ‘securing the due performance of the contract', with the exception of parent company guarantees, the issuer or guarantor does not undertake to compel the contractor to perform the services (which would be out of his or her power in any event). The contractor is incentivised to perform the construction contract by their own autonomous obligations under the same, as well as obligations owed to the issuer under a counter-indemnity.

Performance bonds and guarantees are typically provided by way of on-demand bonds or guarantees, save in exceptional circumstances where the balance of negotiating power between the parties is such that the contractor is able to negotiate a conditional guarantee.

Parent company guarantees

The purpose of a parent or group company guarantee is to provide the other party to the construction contract with recourse to a group company with a better financial standing than the contracting party. This is particularly relevant for international contracting, when the contractor will often set up a subsidiary within the jurisdiction of the employer for the sole purpose of undertaking the specific project. This subsidiary will typically have no assets save for the income paid under the construction contract, which will likely be insufficient to meet the employer's claims if there is substantial non-performance.

The value of such a guarantee depends on the creditworthiness of that group company and care needs to be taken that the guarantee is provided by a group company that holds (and will continue to hold) substantial assets. For smaller construction groups it is normal for the ultimate parent company guarantee to provide such a guarantee. However, many larger, listed international contractors have internal policies limiting access to guarantees from the ultimate parent company to the most significant projects entered into by the contractor, subject to board approval and clear limits on the parent's potential liability.

Retention bonds and guarantees

In construction contracts, the employer is generally entitled to retain a percentage of the contract price (typically 5 per cent) pending completion of the work to form a retention fund. The retention fund is available to the employer to ensure the contractor completes any snagging works and rectifies defects during the defects liability period. It is normal for 50 per cent of the retention monies to be released on practical completion, with the remainder released at the end of the defects liability period.

It is increasingly common for construction contracts to permit the contractor to have an earlier release of the retention monies in exchange for providing an on-demand bond or guarantee. This results in improved cash flow for the contractor without compromising the employer's security.

Payment guarantee

In some cases, where the contractor has concerns regarding the employer's financial standing, the contractor may seek a payment bond or guarantee to cover a percentage of the contract sum. Since the contractor is generally paid in stages as the work progresses, this should provide sufficient protection to the contractor in respect of payments outstanding for completed works. As noted above, in certain jurisdictions and sectors, security for payments will be made by way of standby letters of credit.

Dispute resolution

Security instrument versus construction contract

One of the main challenges in a major international construction project involving multiple parties and multiple contracts occurs when the parties to the various contracts do not sign up to consistent dispute resolution procedures. This is typically the norm regarding security instruments and construction contracts, given that most banks require disputes under the security to be resolved by their local courts, while the construction contract will usually specify international arbitration.

This can cause considerable problems in the context of conditional guarantees. As set out above, a claim under the guarantee requires the same proof that the contractor is liable as would be required if the employer sued the contractor directly. However, in the absence of an express provision in the guarantee that the guarantor will be bound by the findings in proceedings between the employer and the contractor, an award or judgment in those proceedings will not be binding on the guarantor,[24] and in principle, the guarantor would be entitled to demand that the matter be re-litigated. Accordingly, from the employer's perspective it would be preferable if these claims could be consolidated and heard at the same time to avoid the risk of inconsistent decisions. However, unless all parties agree, such consolidation may be difficult to achieve in the context of conflicting arbitration or jurisdiction clauses.

This issue is less pertinent in the context of on-demand bonds. As set out above, an on-demand bond is theoretically independent of the underlying contract and the issuer's obligation to make payment arises on the presentation of the correct documentation. Accordingly, any proceedings between the employer and the contractor under the main construction contract should be of no or limited relevance to the issuer, and there should not be any need for consolidated proceedings. However, as noted above, courts are increasingly showing a willingness to block payments under on-demand bonds and guarantees pending the outcome of the corresponding dispute under the construction contract. 

Claims under the construction contract relating to the security

Where the security is blocked by a court, or the employer refuses to return the security to the contractor for some other reason, the contractor will often bring claims in the arbitration under the construction contract seeking immediate return of the bond or guarantee, and damages in relation to the prolonged duration of the bond or guarantee. The damages typically include the cost of maintaining the security beyond the date when the contractor says the security should have been returned, and losses associated with maintaining the security. Regarding the latter, where a bond or guarantee is blocked pending resolution of the underlying disputes, the contractor's ability to tender for new projects (which themselves require bonds or guarantees) will be restricted,[25] creating the possibility of a claim for loss of opportunity to earn profits on other projects.

Similar claims may be made where the project has been prolonged due to employer-risk events.

[1] Contracts of suretyship … are an area of law bedevilled by imprecise terminology and where therefore it is important not to confuse the label given by the parties to the surety's obligation (although the label may be indicative of what the parties intend) with the substance of that obligation. Because the parties are free to make any agreement they like, each case must depend upon the true construction of the actual words in which the surety's obligation is expressed. This involves ‘construing the instrument in its factual and contractual context having regard to its commercial purpose', a task which the court approaches ‘by looking at it as a whole without any preconception as to what it is.

Vossloh Aktiengesellschaft v. Alpha Trains (UK) Limited [2010] EWHC 2443 (Ch) at [20].

[2] See Andrews and Millett, Paragraph 16-002 and the cases referred to therein, including Trafalgar House Construction (Regions) Ltd v. General Surety and Guarantee Co Ltd [1996] 1 A.C. 199; Marubeni Hong Kong and South China Ltd v. Mongolia [2005] EWCA Civ 395; IIG Capital LLC v. Van Der Merwe [2008] EWCA Civ 542; Vossloh Aktiengesellschaft v. Alpha Trains (UK) Limited [2010] EWHC 2443; Carey Value Added SL v. Gruppo Urvasco [2010] EWHC 1905.

[3] For example, the pro forma performance security demand guarantee provided with the FIDIC Red Book (1999 Edition) requires a written statement that the contractor is in breach of his or her obligations under the contract, and ‘the respect in which the [Contractor] is in breach'.

[4] For example, the FIDIC Red Book (1999 Edition) pro forma proposes that a demand for payment must contain the signature of the relevant minister or the employer's directors authenticated by the employer's bankers or a notary public.

[5] This reflects that, unlike conditional guarantees, on-demand bonds are usually issued by banks and insurance companies.

[6] Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] QB 159 at [171].

[7] See ‘Procuring the security', infra.

[8] Ibid.

[9] Depending on the factual situation, the contractor may request orders from the court preventing the employer from making a demand, requiring the employer to withdraw a demand, preventing the bank from paying out in response to a demand or requiring the employer or the bank to return the security to the contractor.

[10] While this chapter focuses on the approach of the English courts, the authors are aware of injunctions being granted in similar situations in a number of other jurisdictions.

[11] Simon Carves Limited v. Ensus UK Limited [2011] EWHC 657 (TCC).

[12] Ibid, Paragraph 37.

[13] Ibid, Paragraphs 40 and 41.

[14] Doosan Babcock Limited (formerly Doosan Babcock Energy Limited) v. Comercializadora de Equipos y Materiales Mabe Limitada (previously known as Mabe Chile Limitada) [2013] EWHC 3201 (TCC).

[15] A detailed discussion of the law of suretyship is outside the scope of this chapter and readers are recommended to consult specialist texts in this area, such as Andrews and Millet, Law of Guarantees, Seventh Edition, 2015 or Phillips, O'Donovan and Courtney, The Modern Contract of Guarantee,Third Edition, 2016.

[16] Holme v. Brunskill [1978] 3 QBD 495; Andrews and Millett, Paragraphs 9-023-9-028.

[17] Andrews and Millett, Paragraphs 9-029-9-034.

[18] A standby letter of credit will typically require presentation of documents (often signatures from the employer confirming that payment is due) in order to payment to be made under the instrument. An employer who issues a standby letter of credit to make or secure payment may be able to block payment under the standby letter of credit by refusing to provide the required documents or signatures. Where the English courts have jurisdiction over the letter of credit, the contractor may be able to seek judicial assistance. Section 39 of the Senior Courts Act 1981 permits the English High Court to direct a person to execute any conveyance, contract or other document, or indorse any negotiable instrument, and to step in and execute the document or indorse the negotiable instrument if that person fails to comply. This power has been used in relation to payments under letters of credit. See, for example, Astro Exito Navegcaion SA v. Southland Enterprise Co Ld (No 2) (Chase Manhattan Bank NA intervening) [1983] 2 AC 787; Jack: Documentary Credits (Fourth Edition) at 9.85.

[19] Some banks will require that the contractor provide in addition an assignment of the proceeds of the construction contract as a condition of issuing the guarantees or bonds.

[20] The potentially catastrophic consequence of calling an on-demand guarantee or bond explains why banks may notify the contractor before paying out on the demand.

[21] SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication, a cooperative utility of banks headquartered in Belgium.

[22] See the English House of Lords decision Shanning International Limited v. Lloyds TSB Bank plc; Lloyds TSB Bank plc v. Rasheed Bank (2001) 1 WLR 1462 (HL). EU Regulation No. 3541/92 prevented performance of a supply contract in Iraq. The supplier's performance was guaranteed by an on-demand guarantee issued by a local bank in Iraq and counter guaranteed by Lloyds Bank in the UK. Article 2 of EU Regulation No. 3541/92 prohibited satisfaction of any claims ‘under or in connection with a contract or transaction the performance of which was affected, directly or indirectly, wholly or in part by the measured decided on pursuant to [the relevant UN Security Council] resolutions'. The House of Lords found (1) a claim under the performance guarantee was a claim ‘under or in connection with' the supply contract, performance of which was prohibited under EU Regulation No. 3541/92; and (2) Article 2 of EU Regulation No. 3541/92 permanently prohibited a claim being satisfied in relation to the non-performance, including a claim from the issuing bank against the bank who had provided the counter guarantee.

[23] For example, the FIDIC Red Book (1999) provides an example proforma of tender security; the security to be provided by all prospective tenderers (referred to as the ‘Principal' in the proforma) as a condition of submitting a bid. Any demand must be submitted within 35 days after the expiry of the validity of the tenderers' tender and include signatures of the prospective employer (the ‘beneficiary') authenticated by the beneficiary's bankers or a notary public. The tender security can be called in the following situations: (1) if the tenderer withdraws its offer after the latest time specified for submission and before the validity of the offer expires; (2) if the tenderer refuses to accept the correction of errors in his offer in accordance with the conditions of tendering; (3) if the beneficiary awards the contract to the tenderer, and the tenderer fails to sign the contract agreement within 28 days from when it receives the letter of acceptance (or a different period as may be agreed); or (4) if the beneficiary awards the contract to the tenderer, and the tenderer fails to provide compliant performance security to the beneficiary within 28 days from when it receives the letter of acceptance (or a different period as may be agreed). 

[24] Re Kitchin Ex p. Young (1881) L.R. 17 Ch. D. 668; Alfred McAlpine Construction Ltd v. Unex Corpn Ltd (1994) 38 Con LR 63, CA.

[25] As noted above, because the contractor must provide security to the value of the bonds and guarantees procured, there is a limit on the value of the bonds and guarantees that the contractor can procure at any given time.

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