A presentation given on 11 December 2009 on performance bonds on international construction projects.

1. Session 4
WORKSHOP I:
Performance Bonds
Francis Ho, Senior Associate Energy & Infrastructure Project Development:
e-mail: fho@kslaw.com Legal and Commercial Issues for Major Projects
Phone: +971 2 652 3426 London, UK
Mobile: +971 50 557 0446 11 December 2009

2. Performance Bonds - Introduction
 What is their purpose?
 Parties involved:
(1) Contractor (Principal)
(2) Employer (Beneficiary)
(3) Issuer (Surety)
 Two main types:
(1) Default bonds
(2) On demand bonds

3. (1) Default Bonds - Background
 Originated in early 19th Century
 Guarantee rather than “true” bond
 Requirement to establish Contractor default
 Primarily protect against Contractor insolvency
 Commonly used on projects in the UK
 Mostly issued by insurance and surety
companies

4. Default Bonds – When can Employer draw?
 What are circumstances under which Employer
entitled to payment?
 Employer must usually establish:
 Contractor’s liability under Contract
 Employer has suffered loss
 May require litigation before can claim
 Primarily protection against insolvency

5. (2) On demand Bonds - background
 International - originated in 1970s
 Means of overcoming legal and language
difficulties
 Payable on demand so good for employers
and risky for contractors (especially as there
will be counter-indemnity to Issuer)
 Commonly used on international projects
and some UK power and oil projects
 Usually issued by banks

6. On demand Bonds – When can Employer
draw?
 What are circumstances under which Employer
entitled to payment?
 Payable on first demand
 No requirement to establish Contractor default
or Employer loss

7. Default Bonds - How can a call be prevented?
 Issuer can put Employer to proof
 Issuer’s obligations same as Contractor’s,
therefore Issuer’s liability may be released for:
 Forbearance given by Employer to
Contractor
 Material alteration of Contract without
Issuer’s consent
 Consider including “indulgence” clause to
prevent this
 Expiry event/date occurs

8. On demand Bonds - How can a call be
prevented?
 Very difficult, even if Contractor disputes allegation of
non-performance
 Fraud
 Illegal under governing law in the country of
enforcement to allow the call (consider governing law)
 Lack of good faith (“unconscionability”) - Singapore
 Court order or injunction to restrain Employer from call
or Issuer from making payment on receipt
 Courts generally reluctant to interfere in contract
relations between commercial parties

9. Drafting and Commercial Considerations (1)
For Employers:
 If bond to be on demand, make this clear in
drafting
 Can bond be used to claim liquidated damages?
 Does Issuer have satisfactory financial
covenant?
 Is Issuer based in Employer’s home country? Will
help avoid possible legal uncertainties

10. Drafting and Commercial Considerations (2)
For Contractors:
 What is cost? Has bond been “priced for”?
 If Employer’s main concern is Contractor’s insolvency, will
default bond suffice?
 Unfair calling insurance and Uniform Rules for Demand
Guarantees
 Clause in Contract to allow Contractor to recover for
overpayment under Bond?
 Is there longstop date?
 Risk of “pay or extend”

11. Drafting and Commercial Considerations (3)
For Issuers:
 Is there longstop date?
 Counter-indemnity with Contractor
 Have they investigated Contractor’s financial
position and ability to perform its Contract
obligations?