A further classification of bonds is between unconditional, or on-demand bonds, and conditional bonds. The latter are those most usually called for in the UK and, in essential commercial terms, are a guarantee against the insolvency of the contractor: the guarantor or bondsman must pay a sum, up to the guaranteed amount, equal to the damages payable by the contractor to the employer for breach of contract. Fault and damages have to be proved by the employer. If things go wrong and the contractor remains solvent, the employer will generally look to it first. The bondsman will usually have cross-guarantees or indemnities from the contractor for reimbursement of sums paid out.
Conditional bonds provide a useful and fairly cheap security. Although rates vary depending on the creditworthiness of the contractor, charges are often in the range of 2-3% of the amount guaranteed (which is traditionally 10% of the contract price), say £10,000-15,000 on a £5m project. They do not usually give rise to serious legal difficulties, although the bond's wording is often archaic (see Trafalgar Construction vs General Surety & Guarantee 73 BLR 32).
The main problems arise in establishing the extent to which the contractor is liable. Statistically however, most cases are decided against bondsmen; there seems to be an almost unspoken presumption that bondsmen should pay up.
On-demand bonds are called for on many international development projects and on some large projects in the UK, particularly those for which tenders from international contractors are invited. This type of bond is given usually by a bank and is payable by the bank to the employer. No proof of fault or liability on the part of the contractor is required. The bank is, normally, safe because it will have effective counter-indemnities from the contractor. Again, such bonds are not peculiarly expensive – between 0.25 and 1% of the value of the bond per year.
What English law does not take account of is the impact on the contractor of the on-demand bond being called
It is very difficult in the UK for contractors to prevent demands being made or the bank paying out pursuant to on-demand bonds. There are very limited exceptions such as fraud and illegality, and the courts will require clear evidence of these before interfering. Once the money is paid by the bank, it is implicit (and sometimes explicit) that it will be brought into account as between the employer and the contractor (see Cargill International vs Bangladesh Sugar [1996] 4 All ER 563); in the long term, therefore, the contractor should be credited with the amount paid out under the bond.
What English law does not yet take into account is the temporary impact on the contractor caused by the on-demand bond being called. Ten per cent is a large chunk of the contract sum, and the bank, having paid out on the bond, recovers immediately from the contractor. Apart from the cash drain, banks will often limit the amounts bonded by them for a contractor: it thus inhibits the firm from securing further contracts for which bonds are required.
Other countries' courts adopt a commercially more realistic approach. In Singapore, for instance, the courts will prevent payments being made on a bond where the party calling on the bond is acting "unconscionably" (see McDonnell Dowell vs Sembcorp and Samwoh Asphalt vs Sum Cheong [2002] 9 BLR). For instance, if the employer calls in a bond in circumstances where there is no reliable evidence that the contractor is in breach or if the employer has retentions in hand, the employer would be acting unconscionably, and the courts will prevent the bank from paying.
Postscript
Robert Akenhead QC is a barrister specialising in construction law at Atkin Chambers and joint editor of Building Law Reports.
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