Performance Bonds And Bank Guarantees: Interpretations And Demands

Published date09 September 2021
Subject MatterCorporate/Commercial Law, Litigation, Mediation & Arbitration, Real Estate and Construction, Contracts and Commercial Law, Trials & Appeals & Compensation, Construction & Planning
Law FirmMahWengKwai & Associates
AuthorMr Raymond Mah

Introduction

(1) Performance bonds and bank guarantees are commonplace in the Malaysian construction industry. Construction contracts often require a contractor to take out a performance bond, typically in the form of a bank guarantee which can be called upon by the employer to a specified maximum limit in the event of the contractor's breach of the construction contract.

(2) Performance bonds are typically given prior to the commencement of the contract, when the relationship between parties is positive. In contrast, calls on performance bonds are usually made after negotiations fail and communication has broken down. It is little wonder that demands on performance bonds are frequently opposed and challenged.

(3) In deciding disputes on performance bonds, the courts ought to undertake a straightforward exercise of interpretation of the performance bond and defer to the intention of the parties. The parties here refer to the principal (usually the contractor), the guarantor (usually a bank) and the beneficiary (usually the employer). This article examines the various interpretations of performance bonds and the requirements of a valid demand, with reference to Malaysian case law and examples of valid and invalid demands.

Interpretation of performance bonds

(4) In the interpretation of performance bonds, the Malaysian courts have generally come to three different constructions based on the varying words used in performance bonds. These three possible constructions were first considered by the English Court of Appeal in Esal (Commodities) Ltd & Anor v. Oriental Credit Ltd & Anor [1985] Lloyds' Rep 546 at 550 and have been adopted by the Federal Court in China Airlines Ltd v. Maltran Air Corp Sdn Bhd & Another Appeal [1996] 2 MLJ 517 at 534-536 and Kerajaan Malaysia v. South East Asia Insurance Bhd [2000] 3 CLJ 705 at 711.

(5) The three possible constructions of a performance bond are summarised by the Federal Court in SEA Insurance:

"There are three possible meanings which can be given to the [performance bond].

First, no more than a mere written demand is required.

Secondly, the demand must assert a failure to perform the contract.

Thirdly, because of the word "damages", proof thereof and not mere assertion is required before liability under the bond arises."

Firstly, "A mere written demand"

(6) The words of certain performance bonds do not require anything more than a mere written demand to call on the performance bond. The Court of Appeal in Teknik Cekap Sendirian Berhad v. Public Bank Berhad [1995] 4 CLJ 697 at 702 affirmed by the Federal Court in [1998] 3 MLJ XXV cited two such examples:

"There is no doubt that some performance bonds must be paid merely on a demand being made, and whether this is so must depend on the wordings of the bond itself.

In Kirames Sdn. Bhd. v. Federal Land Development Authority [1991] 2 MLJ 198 the guarantee provides that the guarantor shall "irrevocably and absolutely guarantee payment on demand without having to assign any reason whatsoever for such demand." In the light of these clear and unambiguous wordings it can be said that this is an unconditional and a pure "on demand" bond. What is required to trigger payment in such bonds is the demand simpliciter.

In Esso Petroleum Malaysia Inc. v. Kago Petroleum Sdn. Bhd [1995] 1 AMR 189 the then Supreme Court on examination of the performance bond in that case held that it was a pure on demand guarantee and therefore a mere demand would trigger off the guarantees without asserting any reasons thereto. In that case the guarantor "unconditionally and irrevocably guaranteed payment ..."

(7) Traditionally, such performance bonds have been branded as "unconditional" or "on-demand". However as disussed below, there is little utility in classifying the bond as such, especially if it distracts from a plain interpretation of the words of the bond.

Examples of a mere written demand

Kirames Sdn. Bhd. v. Federal Land Development Authority [1991] 3CLJ (Rep) 27 (High Court)

(8) The words of the security guarantee inKirames read:

"(a) the said sum of Ringgit RM117,535 shall be paid by us forthwith on demand by you in writing without your having to assign any reason whatsoever for such demand.

(b) the said sum of Ringgit RM117,535 shall, be paid by us forthwith to you irrespective of whether or not there is any dispute between the said contract and yourselves (the authority) in respect of or relating to the said contract or in respect of any other matter and irrespective of whether or not such said dispute, if any, has been settled, resolved, litigated or adjudicated upon or otherwise howsoever."

(9) Accordingly, it was not necessary for the Court to consider whether the demand had stated the basis for calling on the guarantee. This guarantee has been described by the Court of Appeal in Teknik Cekap as a "pure on demand bond" requiring merely a "demand simpliciter" to trigger payment.

Esso Petroleum Malaysia Inc. v. Kago Petroleum Sdn. Bhd [1995] 1 CLJ 283 (Supreme Court)

(10) Likewise, the words of the bank guarantee in Esso Petroleum did not require the demand to state the grounds or basis for such a demand. The bank guarantee read:

"In consideration of Esso Production Malaysia Inc. (EPMI) agreeing to release to Perbadanan Ladang-Ladang Tabung Haji Sdn. Bhd. (PLLTH) the sum of DM466,562 (Four hundred sixty six five hundred sixty two only) being the amount of liquidated damages (L/D) presently withheld by EPMI pursuant to several purchase Orders made between EPMI and PLLTH, we hereby Unconditionally and Irrevocably guarantee the payment to EPMI, the Ringgit equivalent of the...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT