12 February 2016

Dealing with "Bad Calls" on Bonds

A recent Court decision in Singapore is the latest to look at the question of an “unconscionable” call on a bond. This covers bond calls which are effectively an abuse of the benefit of a performance bond, which I suggest is a significant issue in the Gulf construction world. 

Performance bonds are used on just about every construction and engineering project in the Gulf region and their influence here is greater than in other places. The problem is a combination of the type of bond usually insisted upon in the region, the values of them and the ways in which they are used or threatened to be used.

In this region, the standard requirement is an on-demand bond in which the provider agrees to pay out on any call without requiring any proof of Contractor default or of the loss caused by that default. The consequences for the Contractor are enormous – not just having to indemnify the provider for the sum paid out but the effect on the Contractor’s ability to get new bonding and on banking arrangements generally, plus having to declare the call when making future tenders.   

Whenever there is a falling out between parties the bond is often brought into play, in the form of a straightforward threat by the Employer to call the bond. Of course this is legitimate where the problem genuinely involves failure by the contractor and the prospect of the Contractor being unwilling or unable to give full monetary compensation for that failure. In reality the threat is often made indiscriminately in circumstances where there is no real problem with Contractor failure, indeed the falling out can be wholly about the failure of the Employer to make payments in the correct amount, on time or at all. In these situations, the threat of a call on the bond is pure leverage. The question is whether such a threat can be extinguished when a bond call would not actually be fraudulent but is clearly an abuse of the facility. The question of an unconscionable call has been subject of many Court decisions worldwide.

A fraudulent bond call is always going to fail. Whether this is written into the bond or not, this will be a good reason for the bond provider to refuse it – or for a Court to grant an injunction against the call – but this hardly ever happens. In real life, an Employer does not need to do anything which is obviously dishonest. An Employer under pressure about payment or delay and disruption claims can create some flimsy case about contractor failure and make the threat. Without proving that the case is baseless and that the Employer knows it to be so, it is impossible to show fraud, but this is still unconscionable. So, can anything be done in these circumstances to prevent a bond being called or to prevent payment being made?

In CKR Contract Services Pte Ltd v Asplenium Land Pte Ltd the parties had agreed that a call on the performance bond may only be restrained “in the case of fraud.” Inevitably the parties fell out and the Contractor sought an injunction against the bond call on the basis that it would be unconscionable. The interesting arguments were not about whether the call was or was not abusive but about whether such a clause is enforceable or is void for breach of public policy. The Contractor’s case was that it cannot be good for the business environment if contracts can take this question away from the Courts and allow abusive bond calls to be made. 

The Singapore Court of Appeal decided to uphold the provision. One of the reasons was that public policy itself could not be identified with great certainty so it is difficult to hold it up as justification for not upholding the agreed terms. Singapore is strong on sticking to the contract. Also, in this case the parties expressly acknowledged that the bond was in lieu of the Employer simply holding the Contractor’s cash. This is true - and in the Gulf we do see cheques being held as performance security – but in my view that does not address the question of whether the taking of that held money might also be unconscionable.

This decision is a welcome reminder to parties and advisors in the Gulf that we need to provide clearly for the limits on calling even an on-demand bond. Public policy in the Gulf is very different from Singapore and this is reflected in the various civil codes. Across (for instance) UAE, Bahrain and Qatar there are clear statements requiring parties to conduct themselves within high standards of good faith, which is additional to the obligation of honesty. Although it is not possible here to make definitive statements about specific contract provisions in each jurisdiction, I suggest that these general legal principles are helpful to parties trying to prevent abusive calls on bonds. There are other practical steps which should be considered, including:

  1. Avoiding on-demand bonds. If the bond is to ensure a pot of money to cover for default then a default bond should suffice.
  2. Provide in the contract for a strong indemnity from the Employer to the Contractor should the bond be called wrongly i.e. where it is later established that there was no default or the loss caused was less than the sum called. FIDIC has a good provision but it can be made stronger to include all the indirect damage to the Contractor’s business.
  3. A notice period before any bond call.

The Gulf region will of course continue to use on-demand bonds. It is to be hoped that their distorting influence on the contractual relationships can be reduced.

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