My Word is My Bond?


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For further information, please contact David Weare, Partner, Fladgate LLP (dweare@fladgate.com)


 

Bonds have been with us since before the time of Shakespeare, and in some cases the wording has not changed much either. Originally a bond was simply a promise to pay a sum of money on a particular date (e.g. “I promise to pay you £100 at the end of the month”). From this “simple bond” the conditional bond was developed, where the promise to pay became void if some other obligation was performed (e.g. I promise to pay you £100, but not if John delivers certain goods or I reimburse your losses up to £100 if he fails to do so”).

The latter has a similar effect to a guarantee, and in the landmark decision of Trafalgar House Construction (Regions) Limited v General Surety & Guarantee Co. Limited (1) it was held that a performance bond expressed in such conditional language was in fact a guarantee, so that the bondsman was entitled to the same defences as the principal obligor (in this case the contractor).

By contrast, the “on demand” bond is the successor to the “simple bond”. The requirement to pay is not dependent on the default of another party, and the courts will only consider whether the demand has been made in accordance with the procedure contained in the bond and is not fraudulent. If a contractor is asked to provide such a bond, the issuer (usually a bank) will normally have obtained financial security before doing so. For this reason, an on demand bond is considered onerous from the contractor’s point of view.

However, the words “guarantee” and “on demand” are not conclusive in themselves, and the courts will consider the substance of the bond before deciding whether it is an on demand bond or a guarantee, as illustrated by a number of recent cases.

In Vossloh AG v Alpha Trains (UK) Limited (2) the parent company of a locomotive manufacturer entered into a document expressed as a “guarantee and indemnity” in which it promised to pay “on demand” any monies owed by a group company. The obligation was stated to be a separate and independent obligation. However, the court held that, where the bond was not given in a banking or similar context, there was a strong presumption that the payment obligations did not constitute an on demand bond. As the presumption had not been rebutted, the document was treated as a guarantee and not an on demand bond.

In Meritz and Marine Insurance Co. Ltd v Jan de Nul NV and another (3) Meritz entered into advance payment guarantees in which it guaranteed to repay on the buyer’s demand advance payments made under three shipbuilding contracts in the event that the buyer became entitled to a refund under the terms of the shipbuilding contract. The court found that the guarantees had three of the four characteristics which would almost always lead to them being construed as on demand bonds: the parties to the underlying transaction were in different jurisdictions; the guarantees did not contain clauses limiting the defences available to a guarantor in a classic guarantee situation; and the undertaking was to pay on demand. The fourth characteristic was that the instrument was issued by a bank. Although in this case Meritz was an insurance company, the situation was sufficiently similar for the advance payment guarantee to be treated as an on demand bond.In AES-3C Maritza East 1 EOOD v Crédit Agricole Corporate and Investment Bank and another (4) the bank entered into a performance bond in which it undertook to pay on receipt of a demand containing a statement to the effect that the contractor had failed to comply with its obligations under the engineering contract and also containing any notice to or claim against the contractor relating to the relevant breach. Although the court accepted that the bond was on demand, there had to be a notice or claim against the contractor which supported the demand, and sums not yet due and payable by the contractor under the engineering contract were not recoverable under the bond. In this case, a demand for €93m was accompanied by notices of claim against the contractor for €27m. The court held that the demand was invalid because it did not include notices or claims for the amount demanded, and also because it sought sums that were not due and payable by the contractor under the engineering contract.Bonds are a common feature of both construction contracts and statutory adoption agreements. The above cases demonstrate the importance of establishing whether an on demand bond or a guarantee is intended and making sure that the instrument clearly expresses the parties’


(1) [1995] HL; (2) [2010] EWHC 2443 (Ch); (3) [2010] EWHC 3362 (Comm); (4) [2011] EWHC 123 (TCC)


 

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