Performance Bonds And Construction Contracts

A recent Australian case highlights the dangers of

providing unconditional performance bonds to support

international construction contracts. Contractors should

consider offering conditional bonds or including protective

clauses in their contracts.

Performance bonds are a common feature of many types of

construction contracts, particularly in international projects.

These bonds are issued by a bank directly to the employer. If

the employer "calls" on the bond, the bank must pay

the employer up to the limit of the bond. The contractor in

turn will be obliged to repay these amounts to the bank.

Performance bonds can be conditional or unconditional.

Conditional bonds are only to be paid if the employer shows

that the contractor has failed to perform the contract.

Unconditional bonds on the other hand must be paid by the bank

once a call is made without any reference to the underlying

contractual position. It is for this reason that unconditional

performance bonds are referred to as "cash in

hand".

The danger with an unconditional performance bond is that an

employer may make a call when the contractor has good reasons

for disputing that any breach of the contract has occurred.

This was the case in Clough Engineering Ltd v Oil and

Natural Gas Corp regarding a contract for the development

of oil and gas fields off the coast of India. The Indian oil

company attempted to call on an unconditional performance bond

given by Clough in respect of breaches of the contract. Clough

applied for an injunction against the Indian company to prevent

it from calling on the bond.

The Court refused the injunction because the call had been

made honestly and a dispute between the parties over breach did

not prevent payment under the bond. The case was decided in

Australia which has a slightly broader approach than England.

In Australia, payment can in some circumstances be stopped by

the Court if the parties have specifically agreed between

themselves that calls will not be made unless the contractor is

in breach. In England, a contractor needs to show that the call

was fraudulent or dishonest before the Court will act to stop

the payment.

Contractors should think seriously before agreeing to

provide unconditional performance bonds. If possible,

contractors should attempt to include conditions within the

bond requiring any breach to be proved or certified. If an

unconditional bond cannot be avoided then contractors should

consider including protective measures...