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CLASH ON DEMAND |
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An "on-demand" bond is an undertaking given by a bank to the
purchaser that it will pay to the purchaser on demand the whole or part
of the amount of the bond usually 10-20 per cent of the contract price.
The obligation is unconditional; there is no requirement for the purchaser
to prove default by the contractor or the amount of damages it is entitled
to. Nor is there any right for the contractor to claim to set-off from
the sum payable under the bond the amount of a counter-claim it may have
against the purchaser. The bank's obligation to pay is primary and independent
of the contract. The bond should stipulate that the purchaser must accompany any demand
for payment with a statement setting out the respect in which the contractor
is in breach of contract. The bank will deal only in documents and not
verify their adequacy. In effect, the bond is cash-in-hand and the obligation
of the bank to pay under the bond is similar to that of a bank under an
irrevocable and confirmed letter of credit. Most contractors and some purchasers oppose "on-demand" bonds
for two reasons. First, they can be called without the contractor being
in default. Second, the bank will deduct the amount of the bond from the
total credit it allows the contractor, reducing its ability to undertake
other business. Against these reasons it is argued that under a UK contract no purchaser
would be likely to call a bond without being satisfied that the contractor
was either in default or insolvent and that it would have a bona fide
claim for damages equal at least to the amount of the call on the bond.
Cases of "unfair calling" have arisen on overseas contracts
where purchasers, usually agencies of the government, are notoriously
irresponsible and the UK contractor has no possibility of obtaining redress
under the local legal system. In a UK context, if it were found on settlement
of the contractor's final account that the amount of damages due to the
purchaser was less than the amount paid out under the bond, it is arguable
that the purchaser would be obliged to refund the difference. And if the contractor cannot raise a bond for say, 10 per cent of the
contract price, the purchaser may have concerns over whether the contractor
has the financial resources to perform the contract. Projects in the Middle
East worth millions of pounds have raised bonding problems for British
firms, but those days are gone. There is nothing inherently unfair in an "on-demand" bond.
It can be used unfairly by an unscrupulous purchaser, but so can many
other terms of the contract. What is most unfair is a system of bonding
which denies to the purchaser access to cash when the contractor is in
serious default or insolvent. In either event, the purchaser will have
to bring in another firm to finish the uncompleted work. But replacing
a contractor is neither cheap nor easy. In these circumstances the purchaser
needs immediate access to funds to finance the additional costs incurred. A recent case in the House of Lords has demonstrated that a performance
bond in the traditional form annexed to one of the industry standard forms
of contract either Joint Contract Tribunal, Institution of Civil Engineering
or model forms is incapable of meeting the purchaser's needs (see
this page). Disliking on-demand bonds, but recognising the current weakness, the
ICE is attempting with the banks and the British Association of Insurers
to produce an acceptable form of default bond. This would provide for
the default and the amount due under the bond, taking into account cross-claims,
to be determined by adjudication within limited time periods. But given
the complexity of claims and counterclaims, the practicality of rapid
adjudication is doubtful, especially as the insurers want to involve themselves
in proceedings. At present, the advice to purchasers is to insist on the
contractor providing an on-demand bond from a bank. SM Peter Marsh and Frank Griffiths are associates at project strategy and contract management consultancy FGA Ltd, tel: 0116 279 3383 |
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