Features - Legislation

A bond or a guarantee?

Kim Teichmann, Senior Associate, Thomas Eggar.

There have been several high profile cases in the Court of Appeal recently which have looked at the legal nature of guarantees and bonds. The use of performance bonds and advance payment bonds are common place in the construction industry and the recent economic challenges have seen an increase in their use.

In the recent case of Wuhan Guoyu Logistic Group Co Ltd and others v Emporiki Bank of Greece SA [2012] EWCA Civ 1629 the Court of Appeal tried to provide a clear set of rules so that the business community would know whether they were dealing with a demand bond or a guarantee. The problem is that drafters often get the labels wrong and even if a document is called a guarantee, it may be a bond and vice versa.

What is the difference you may ask? It is fundamental. If you want to be guaranteed payment of a sum of money on the happening of a certain event, even if the parties are in dispute at the time, then you need a bond. The bondsman has to pay up on demand usually upon the presentation of a few documents, irrespective of the underlying merits of the claim. The debtor cannot say that he doesn’t owe the money. Provided the documents are presented to the bondsman, you get your money. These type of bonds are often used for advance payments for expensive plant, machinery or pre-fabricated items, especially when large sums of money are being sent to uncertain jurisdictions where pursuing the debtor would be futile.

In contrast to a bond, a guarantee only guarantees due performance of the contract. In the construction context, most performance bonds are in fact guarantees. The bondsman will only pay the damages suffered by the employer due to the contractor’s non performance of the construction contract. The employer has to prove that there has been non performance and prove the damages are due before the bondsman will pay.

There are many technicalities related to a guarantee which could result in the issuer of the guarantee being let off the hook. For example, to name but one, if the employer decides to make advance payments under the contract to the contractor who is struggling, this will be deemed to prejudice the issuer of the performance bond. Unless there is a clause which allows such an act (called an indulgence clause) in the bond, the bondsman could refuse to pay under the bond.

There are many standard forms of bonds and one would think that if you used a standard form you would be in good hands. This is a dangerous assumption to make. If one looks at some standard form of bonds, they look very much like on demand bonds because they say that they will pay on demand with the production of a piece of paper and they say that the demand is conclusive evidence that the sum demanded is due.

These are all characteristics of an on demand bond. However the same document then goes on to exclude certain defenses available to the bondsman – a characteristic of a guarantee.

The only answer is to always have an advance payment bond, a performance bond or a guarantee checked by a lawyer. You need to be clear about whether you want your money without an argument or whether you are prepared to prove the underlying claim before you get your money. It is then advisable to make it your solicitor’s responsibility to achieve this. At least you will be sure that you get what it says on the tin.