Performance Bonds - UAE Perspective

Most, if not all, construction contracts, whether standard forms or bespoke contracts, require the Contractor to provide the Employer with a performance bond guaranteeing the Contractor's performance under the contract. The purpose of such performance bonds is to provide the Employer with an efficient and fast remedy should the Contractor default in carrying out its obligations under the construction contract.

The Employer's right to liquidate this performance bond is triggered upon the occurrence of a certain default on the part of the Contractor. It is not an absolute right to the Employer and the decision to liquidate a performance bond has to be exercised with caution.

It is accepted that an Employer has the right to liquidate the performance bond if the Contractor has clearly defaulted on its obligations, such as in the event of abandoning the works or refusing to proceed with the works for no reason.

However, when the relationship turns sour between the Employer and the Contractor, there appears to be a tendency by employers to liquidate the performance bond even without sufficient causation. In instances where the Contractor is not in default or its default is not sufficiently grave to warrant the liquidation of its performance bond, the Employer has no right to liquidate the performance bond.

During the Dubai financial crisis that started towards the end of 2008, many employers have relied on performance bonds as a quick method of receiving liquidity. These practices have caused great harm to many contractors who as well as not being paid at the time, were also being subjected to the liquidation of their bonds. This has also caused difficulty for many contractors to later obtain performance bonds from banks.

Performance bonds are essentially letters of guarantee issued by a bank on the request of the Contractor, by which that bank undertakes to make a payment to the Employer upon the Employer's demand.

The UAE Federal Commercial Law No. 18/1993 (the Commercial Code) regulates, inter alia, the issuance and use of letters of guarantee and defines them in Article 414 thereof as:

"an undertaking issued by the guaranteeing bank on the request of his client to pay a certain amount (or an amount that can be ascertained) to another person (the beneficiary) without restriction or condition, unless the letter of guarantee is conditional, if [the bank] is requested to do so within the period specified in the letter of guarantee. The letter of...