PERFORMANCE SECURITIES

INTRODUCTION

In the construction industry, contractors are often exposed to risks of financial difficulties.
These may be caused by poor management, cashflow problems, underbidding, insufficient
resources and payment disputes. Whatever the cause or causes, measures should be taken to
prevent or reduce such losses.

Performance securities are a type of safeguard that employers can use to provide as security
for the contractor’s performance. Occasionally employers will undertake them to provide
sureties to guarantee payment to a contractor. The range of these securities is wide and often
many are drafted to cater specifically for individual projects.

Broadly speaking, these can be divided into three categories: guarantees, bonds and
warranties. Each category will be examined separately as set out below.

I. BONDS AND GUARANTEES

1. By definition, a bond is a promise by deed (i.e. a document executed under a seal)

whereby the person giving the promise (bondsman) promises to pay another person
(the obligee or beneficiary) a sum of money. In construction contracts, bonds will
often support payment or performance obligations.

2. In contrast, a contract of guarantee is a promise to answer for the debt, default or

miscarriage of another person. An ancillary contract of guarantee or suretyship is
frequently entered into as a form of security against the default of one of the parties to
the contract or of a person concerned with it. The person giving the guarantee is
termed a surety. The surety may guarantee performance by the contractor, payment by
the employer or the reliability of the architect or any other person connected with the
contract that may have responsibility with for money.

Differences between Bonds and Guarantees

3. Often it is hard to distinguish between a bond and a guarantee as the two are very
similar. To distinguish between the two it is necessary to consider the legal obligations
that each serve.

4. There are two types of obligations: primary and secondary. Bonds fall into the first
category and guarantees fall into the latter.

5. A primary obligation is one in which the person undertaking the obligation, the obligor,
is liable to the person benefiting from it, the obligee, without reference to the liability
of any other person. Hence, it operates separately from the construction contract.

6. A secondary obligation is where the obligor promises that a third party will perform an
obligation owed to the obligee or perform the obligation itself or to pay damages if the
third person fails to do so. Its enforceability is conditional upon a breach of an
obligation owed to the obligee by a third party. A secondary obligation is classed as a
 -2-

suretyship obligation (a guarantee). Hence, a secondary obligation is closely connected

with the construction contract so that a breach of the contract will automatically be a
breach of the guarantee.

7. At times the type of obligation is not so clear-cut especially when both obligations are
contained in the same document. Questions have arisen as to when and whether a bond
is a guarantee. This issue was considered in the case of Trafalgar House Construction
(Regions) Ltd. General Surety and Guarantee Co. Ltd (1995) 73 BLR 32(HL).

8. Trafalgar House were the main contractors for the Mote Park Leisure Centre at
Maidstone in Kent. The sub-contractors, KD Chambers Ltd, took a bond issued by the
defendants as security for obligations of the groundworks. The bond was worded as
follows

"By this bond, we K D Chambers Ltd ... and General Surety and Guarantee Co Ltd
are held and firmly bound unto a Monk Building and Civil Engineering Ltd in the
sum of... for the payment of which sum the subcontractor and surety bind
themselves ... if the subcontractor shall duly perform and observe all the terms
provisions conditions ...of the said subcontract on the subcontractor's part to be
performed and observed... or if on default by the subcontractors the surety shall
satisfy and discharge the damages sustained by the main contractors ... then this
obligation shall be null and void but otherwise shall be and remain in full force and
effect... "

9. At the Court of Appeal, Saville J considered the nature of the surety.

"What then is the nature of the obligations created by the bond? In my judgment,
the correct approach is to consider the bond in light of the purpose for which such
instruments are created. It seems to be that this purpose is clear ... what the bond
does is to impose upon the surety an independent obligation to pay the damages
sustained by the main contractors (up to the amount of the bond) from a failure of
the subcontractors to carry out the subcontract. In the present case, it is common
ground that the subcontractors failed to property perform the subcontract. The
main contractors have asserted that the damages they have sustained thereby
greatly exceed the amount of the bond. They have accordingly demanded payment
from the surety of the amount of the bond. It is not suggested that in doing so the
main contractors have acted otherwise than in good faith. In my view, the main
contractors are entitled to judgment."

10. It was held that the bond was not a contract of guarantee but a separate and
independent contract by the guarantor to make payment and that the guarantor's
obligation was to pay up to the full amount of the bond the amount of damages
asserted in good faith by Trafalgar House.

11. It is interesting to note that while the Court of Appeal eventually found the purpose of
the bond to be clear, their Lordships condemned the drafting as "archaic and
unsatisfactory" (Saville LJ at p 56) and "archaic, difficult to interpret and ill-suited to
its obvious commercial purpose" (Beldam LJ at p 59). The Law Lords in Trafalgar
 -3-

House were no more than echoing the words of Lord Atkin in Trade Indemnity Co Ltd
v Workington Harbour and Dock Board [1936] 1 All ER 454, 459:
"I may be allowed to remark that it is difficult to understand why businessmen
persist in entering upon considerable obligations in old-fashioned forms of
contract which do not adequately express the true transaction."

II. GUARANTEES

Nature and Purpose

12. As mentioned above, a guarantee may be thought of as a contract between parties in

which one party, the surety, undertakes to pay a sum of money to the other party, a
beneficiary, if the main obligations of a third party, principal debtor, to pay the money
is not fulfilled. In the construction context, the surety is typically a bank, insurance
company or a parent company; the beneficiary is normally the employer and the
principal debtor is often a contractor.

Types of Guarantees

13. There are many types of guarantees associated with construction contracts. The more
common types include:

(i) Guarantees of due and comprehensive performance by the contractor of all his
various contractual obligations. This would include that of parent company
guarantees and performance bonds. Performance bonds will be discussed
separately below.

(ii) Guarantees of the payment obligations of a contracting party owed by him in

respect of the work or goods to be carried out or supplied by the other party.
This would usually be a guarantee to ensure there are sufficient funds for the
owner or main contractor to pay the contractors and as such this would
normally be the owner's or main contractor's obligation.

Parent Company Guarantee

14. The usual form of guarantee required by an employer is a guarantee from a parent
company of a contractor as the parent company would usually have more substantial
assets than its subsidiary. The guarantee will be a contract by the parent company
either agreeing to perform the contract on the default of the main contractor, or
agreeing to answer by way of security for the liability of the contract to the employer.
As such, a guarantee is usually a secondary contract inline with the obligations of the
contractor.

15. The reason why parent companies usually provide the guarantees is that banks,
insurance companies and financial institutions are reluctant to take on an unquantified
risk.
 -4-

Guarantees as Payment for Works/Supplies

16. Guarantees can also function the other way around. A client can give a guarantee of
payment to a contractor. This can be illustrated in the case of Try Build Ltd. v Blue
Star (1999) 66 ConLR 90, where a client found itself unable to continue paying a
contractor that had already begun doing work for it.

17. A contract was signed between the client, contractor and a third party whereby the
third party engaged itself to pay the contractor the amount stipulated in the initial
contract between the client and the contractor. The case arose because the third party
subsequently refused to pay the full amount. The court held, however, that the amount
that was owed was the amount agreed to in the guarantee and that the third party
could not back away from the guarantee it had previously made.

Defences to liability under a guarantee for banking facilities

18. As guarantees are secondary liabilities, the courts have traditionally interpreted them
benevolently in favour of the guarantor. Accordingly, employers often seek to include
sufficient protective clauses into their guarantees to prevent any unintended
termination. Such clauses are usually incorporated into ancillary provisions to protect
the employer's position as beneficiary under the guarantee and to avoid the guarantor
taking action which would reduce the benefit of the guarantee. For instance, provisions
prohibiting the guarantor from proving for debt on the insolvency of a contractor (save
to the extent that the employer's claim) is fully satisfied.

19. A guarantor will often require a contractor to issue an indemnity as a condition of the
liability. In Liu Char Hing Bank Ltd v Ocean Importers & Exporters Co Ltd & Ors
[2001] HKEC 669, the Court of First Instance addressed various defences to liability
under a guarantee for banking facilities. The defences argued included: non est factum,
economic duress, undue influence, misrepresentation and estoppel. Hon Sakharani J
provided a helpful re-statement of the requirements necessary to successfully defend
liability under each of the defences.

Duration of Guarantee

20. The duration of the guarantee will also be an issue and employers will seek to extend it
beyond completion of the project and contractors will seek to limit it so far as possible.
If a guarantee for instance has a time limit then the guarantee obligation can be
expected to end with it: Bollore Furniture Ltd & Anor v Banque Nationale de Paris
[1983] 14KLR 78 (CA).

III. PERFORMANCE BOND

Nature and purpose

21. As mentioned earlier, a bond is a promise by deed whereby the person giving the
promise (the bondsman or surety) promises to pay another person (the beneficiary) a
sum of money. Ordinarily the surety only becomes obliged to make payment when
called upon to do so.
 -5-

22. In the construction industry, the most common type of bond is a performance bond
which serves as primary protection against contractor insolvency within the industry1.
From the employer's point of view, the insolvency of a contractor during performance
of the construction contract will most likely result in delay to project completion and
the incurring of additional expenses in employing a completion contractor to finish the
works. If standard form contracts are used, the employer may hold retention monies
and the outstanding value of the works or materials completed or delivered to site at
the date of insolvency, but this offers limited protection.

23. Performance bonds may either be a mandatory or optional requirement but, for the
above reason, it is common for employers to require contractors to provide a
performance bond from an independent bank or insurance company to enable the
employer to recover damages it may sustain as a result of the contractor's default up to
a stipulated limit, which is often 10% of the agreed contract sum.

24. In short, a performance bond is like a contract of guarantee whereby the surety
promises to pay up to the amount of the bond if the contractor fails to perform his
contract. Under this performance bond, a joint and several obligation is both owed by
the surety and the debtor (contractor) to the beneficiary (employer).

Types of performance bonds

25. There are two types of performance bond:

(i) Conditional bonds; and

(ii) Unconditional or on-demand bonds

Conditional bonds

26. A conditional bond is one which is expressed to be "conditioned" upon a particular

event(s) and commonly upon the satisfactory performance of the contractor. Put
simply, it guarantees to an employer the contractor's due performance of a
construction contract. It has been used extensively in England and in Hong Kong.

27. A typical conditional bond usually provides that the contractor and the surety are "held
and firmly bound" to the employer in a given sum, and then provides for future release
of that obligation either on payment of the bond or upon final performance of the
contractor's obligation.

28. However this archaic type of wording has been criticised as confusing and unduly
complex by the courts in England and in Hong Kong, but it has been decided in both
jurisdictions that this type of bond is akin to a guarantee and is only payable upon
actual proof of default and damages2, such as an arbitration award or court judgment.

1
See article "Protecting against insolvency of contractors in Hong Kong" by Gary K. L. Soo, [Construction Law Journal,
2003, 19(7), 406-418] which explains why the risk of insolvency is particularly elevated within the construction industry
and looks at the steps which Hong Kong contractors can take to safeguard against insolvency.
2
See Tins Industrial Co. Ltd v Kono Insurance Ltd [1987] 42 BLR 110 (Hong Kong CA); Trafalgar House Construction
(Regions) Ltd v General Surety and Guarantee Co. Ltd (1996) AC 199, (HL)
 -6-

The payment will only cover the proven consequential loss sustained by the employer
up to the amount stated in the bond3.

29. In England, in an effort to address judicial criticisms of the usage of archaic bond
language and to meet the modern commercial needs of users (other than lawyers), the
Association of British Insurers ("ABI") published on 22 September 1995 its model
form of contract Guarantee Bond, which was subsequently revised in July 20024. The
ABI believes that its model form of Guarantee Bond safeguards the interests of both
the contractor and employer by linking the surety's payment obligation to the
underlying contract which has been freely negotiated between those parties.

30. In Hong Kong, the Joint Contracts Working Committee of the Hong Kong Institute of
Architects, the Hong Kong Institute of Construction Managers and the Hong Kong
Institute of Surveyors officially launched, on 11 April 2005, the 2005 Edition of the
Standard Form of Building Contract. Despite the fact that it represents the first major
re-draft of the Standard Form of Building Contract used in Hong Kong, the standard
form for "surety bond" 5 is of limited benefit and still retains the type of archaic
wording used in the past.

Unconditional / On-demand bonds

31. Unconditional bond is different in that it obliges the surety to pay up by just a simple
demand or "call" and without proof of default or damage being sustained.

32. The employer will generally receive payment of the full amount upon the presentation
of a written statement to the surety stating that the contractor has failed to perform. In
the absence of fraud and, in certain jurisdictions (e.g. Singapore and some Australian
states) unconscionable conduct, the surety must pay upon the receipt of a demand,
provided the demand notice and any other documents required by the bond are in
order. The issues of fraud and unconscionability are further discussed below.

33. Unconditional bonds have recently become widely used in the international contracting
field and its use has spread to Hong Kong and the South East Asia region generally in
major infrastructure projects.

Distinction between conditional bonds from unconditional bonds in practice

34. The distinction between conditional and unconditional bonds is not always clear due to
ambiguous drafting.

35. Generally conditional bonds can be identified by:

3
See for example, Success Well Investment Ltd v Bank of China Group Insurance Co Ltd v Wai Bo Construction and
Engineering (HK) Co Ltd & Ors [2000] HKEC 687
4
See "ABI Model Form of Guarantee Bond - An Explanatory Guide" (http://www.abi.org.uk/Display/File/535/Model_
Form_of_Guarantee_1995,_Amended_2004.04_-_Current.pdf); also article "Review of the ABI Model Form of Guarantee
Bond, July 2002" by Andrew Pike [Construction Law Journal, 2204, 20(4), 197-205]
5
See Schedule 1 of the Standard Form of Building Contract (Hong Kong - 2005 Edition)
 -7-

(i) the wording which makes payment under the bond conditional upon the proof of
breach of the underlying contract (as opposed to mere notice of a breach) by the
contractor;

(ii) the existence of notice provisions as to the existence of a default or of the

intention to claim, as conditions precedent to any call on the bond;

(iii) the bond being signed by the contractor. Unlike the unconditional bond, the
conditional bond depends on the obligations owed by the contractor to the
employer under the contract, and the contractor must be a party to it; and

(iv) the absence of words typically found in unconditional bonds such as "...on receipt
of its first demand in writing...the bank/surety will fulfil its obligations under the
bond without any proof or conditions...".

36. In respect of unconditional bonds, the Hong Kong Court of Appeal in Dragages et
Travaux Publics (HK) Ltd v Citystate Insurance Ltd [2001] HKC 196, emphasised
that the determining factor of unconditional bonds is the text of the bond itself, that is,
whether the beneficiary would be required to do anything other than make a call on the
bond. In his judgment, Mayo V.P. stated that one of the crucial influences in deciding
whether a bond is conditional or on-demand is how the operative parts of the bond are
put into effect.

37. Since unconditional bonds are potentially oppressive documents, the wording must be
drafted in clear and unambiguous terms to establish that the bond is an unconditional
bond. The Court of Appeal in the Dragages case highlighted the following cases in
which the bonds had been found to be "unconditional bonds".

"...we unconditionally and absolutely bind ourselves to make payment of

USD526,273.15...or as directed by [the defendants] in writing without any question
whatsoever...The Guarantee is unconditional and it is expressly understood that the
sole judge for deciding whether the suppliers have performed the contract and
fulfilled the terms and conditions of the contract will be the [defendants]."6

"We confirm our guarantee ... payable on demand without proof or conditions; ... it is
understood that the said amount will be paid on your first demand..."7

"...the Bondsman shall upon demand made by the Employer in writing and without
proof of the said default or conditions satisfy..."8

"... we undertake to pay you, unconditionally, the said amount on demand, being your
claim for damages..."9

38. The intention of the parties at the time when the bond was entered into is not a
necessary determining factor. In short, a beneficiary of a bond should always scrutinise

6
Cargill International SA v Bangladesh Sugar and Food Industries Corp. [1996] All ER 563 (QBD)
7
Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] QB 159
8
Airport Authority Hong Kong v American Home Assurance Co. [03/02/00] HCA 17807/99
9
IE Contractors Ltd v Lloyds Bank Plc and Rafidain Bank [1990] 51 BLR 1
 -8-

the wording of the bond to ensure it is not a "conditional" bond despite the presence
of the phrase "payable on demand" or words to that effect.

Enforcing an unconditional bond

39. Unconditional bonds have greater commercial advantage to employers in that they are
payable on demand. A unconditional bond is in effect a banking instrument and not a
guarantee.

40. To obtain payment the employer simply has to serve a written demand on the surety at
the given address within the bond's period of validity, and need not prove default on
the part of the contractor or that damages have been incurred by the employer. The
surety must pay and is not entitled to raise defences or cross-claims that would have
been available to the contractor under the building contract; the employer should
therefore obtain summary judgment against the surety.

Enforcing a conditional bond

41. With a conditional bond, enforcement is unlikely to be achieved quickly unless:

(i) the default of the contractor is so obvious that it plainly cannot be disputed;
and
(ii) no defence or set-off is available to the contractor/surety in answer to the call.

42. The usual difficulty with enforcing conditional bonds is where the surety does not
accept that there has been a default on the contractor's part. One must note that a mere
assertion of default and damage will not suffice10. In this regard a surety is entitled to
raise all defences and cross-claims which would have been available to the contractor,
and summary judgment would not normally be available if the occurrence of a default
is a matter which is in dispute.

43. There are also a number of procedural complications arising from enforcement which
sureties may use to resist or postpone payment, which are briefly described as follows:

Early release

(i) Some forms of bond may contain an early release date, for example upon
practical completion of the works. Therefore, in respect of default by a
contractor occurring before completion, the employer should be careful to
check the expiry date of the bond and ensure that a call is made before its
expiry. Furthermore, if the bond is released upon completion, the employer
may lose protection for any default by the contractor occurring post-
completion, for example any breach of the contractor's obligation to remedy
defects. From the employer's point of view, early release provisions in the
drafting of bonds should therefore be avoided.

10
Tins Industrial Co. Ltd v Kono Insurance Ltd [1987] 42 BLR 110 (Hong Kong CA)
 -9-

Condition precedent of notification

(ii) Some forms of bond require as a condition precedent to the employer's right to
recovery that the surety should first be notified in writing of any default by the
contractor. In the English case of Oval (717) Ltd v Aegon Insurance Company
(UK) Ltd [1997] 85 BLR 97, the bond required the employer to notify the
surety of any non-performance by the contractor within one month after such
non-performance. In fact, the employer failed to notify within the specified
period and it was held that this non-compliance with the condition precedent
disentitled him from recovery under the bond.

(iii) In complex construction contracts it is administratively difficult for the

employer to notify the surety of every act of default as it occurs, and therefore
the use of bonds with notification provisions such as the above should be
resisted by employers.

Conditioning of a bond expressly upon a judgment or reward

(iv) Some forms of bond may require as a condition precedent to recovery that the
employer first obtains judgment or an award in arbitration against the
contractor. This type of provision would seem to be unduly restrictive and
should be resisted by employers when reviewing or approving forms of bond.

Form of demand

(v) It may be a requirement of the bond that any call should be made in a specified
form, for example with an accompanying certificate from the architect or
engineer that the contractor is in default. In these circumstances, those
concerned with drafting demand letters should ensure that the form complies
strictly with the requirements of the bond.

Conditioning of the bond upon certification of additional costs of completion

(vi) Most of the standard forms of construction contracts provide for an account to
be taken after completion of the project by the completion contractor, or any
damages to the employer arising from termination. Depending upon the precise
wording of the contract, this may prevent the employer from immediate
recovery of damages under the building contract.

(vii) If the express wording of the bond provides that the employer's rights under the
bond are precisely co-extensive with his remedies under the contract, the surety
may contend that it is premature for a call to be made under the bond before
the damages have been ascertained under the building contract11. On the other
hand the wording of the bond may permit an earlier claim for damages against
the surety12.

11
Paddington Churches Housing Association v Technical and General Guarantee (1999) BLR 244
12
as in Nene Housing Society Ltd v National Westminster Bank Ltd (1980) 16 BLR 22
 - 10 -

(viii) Accordingly, it is not recommended legal proceedings be commenced to

recover bond money unless it is clear that the default and damage is
undisputable.

Grounds to resist enforcement of bonds

44. Despite the fact that unconditional bonds oblige the surety to pay simply on demand,
there are very exceptional circumstances where the surety may be in a position to
decline to pay and can be restrained from paying by injunction obtained by the
contractor, (who will probably have given a counter-indemnity to the surety). These
exceptional circumstances are listed below.

Conformity of Call

45. The call must be worded to conform with the requirements of the bond. For example,
if the bond requires that the beneficiary of the bond states the reasons for the call, or
provides an address to which the demand should be sent, the demand must comply in
order for the beneficiary to recover. However it would appear that the doctrine of
strict compliance which has evolved in relation to letters of credit will not be applied
so rigorously in the case of performance bonds13.

Fraud

46. The courts in Hong Kong and England will not enforce an unconditional bond if there
is clear evidence of fraud on the part of the beneficiary in calling on the bond14.

47. In these circumstances, fraud is defined very narrow. The burden of proof is a high
one: it is not sufficient to show that there is a strongly arguable case of fraud; the
applicant for an injunction must be able to show that the only realistic inference from
the facts is that the demand was fraudulent and that the bank was aware of the fraud
(GKN Contractors v Lloyds Bank plc (1985) 30 BLR 48; United City Merchants
(Investments) Ltd v Royal Bank of Canada [1983] 1 AC 168, [1982] 2 All ER 720;
United Trading Corpn v Allied Arab Bank [1985] 2 Lloyd's Rep 554).

48. However, in practice and in the context of building contracts, it may be very difficult
for a bondsman to establish that the call on the bond is fraudulent. For example, in the
Hong Kong case of UDL Kenworth Engineering Ltd v Airport Authority Hong Kong
and American Home Assurance Co. [1998] 705 HKCU 1, the Plaintiff was a sub-
contractor of Nishsimatsu Construction Company Ltd ("Nishsimatsu"), the main-
contractor engaged by the 1st Defendant to carry out works for the airport at Chek
Lap Kok. Nishimatsu had sub-contracted certain works to the Plaintiff and pursuant to
the terms of the sub-contract, the Plaintiff procured the issue by the 2nd Defendant of
a performance bond in favour of the 1st Defendant. As time progressed, Nishimatsu
was dissatisfied at the Plaintiff's slow progress of works. It had written to the Plaintiff
more than 12 times, between 19 January 1998 and 30 March 1998, complaining of the

13
IE Contractors Ltd v Lloyds Bank Plc and Rafidain Bank [1990] 51 BLR 1
14
Bollore Furniture Ltd v Banque Nationale de Paris [1983] HKLR 78; Bolivinter Royal SA v Chase Manhattan Bank
[1984] 1 Lloyds' Law Rep. 251
 - 11 -

Plaintiff's performance. Eventually, Nishimatsu wrote to the Plaintiff that the Plaintiff's
persistent failure to proceed with diligence and their inability to complete the works by
the completion date showed that the Plaintiff did not intend to be bound by the terms
of the sub-contract which comprised a repudiation on the part of the Plaintiff. The 1st
Defendant was made aware of this by Nishimatsu and subsequently wrote to the 2nd
Defendant demanding immediate payment of the performance bond given by them in
respect of the Plaintiff on the grounds that the Plaintiff is in default of its obligations
under the sub-contract. The Plaintiff objected to this, contending that Nishimatsu was
the defaulting party, not them.

49. In its judgement, the Court of First Instance ruled in the Defendants' favour and stated
that a demand must be made bona fide, not fraudulently or dishonestly. In the present
case, the fact there is a serious dispute between Nishimatsu and the Plaintiff does not,
per se, make the demand by the 1st Defendant in calling in the bond dishonest or
fraudulent. The 1st Defendant is entitled to rely on the representation of Nishimatsu
that the Plaintiff is in default of the sub-contract and provided that their belief is an
honest one based on the representation of Nishimatsu, even if it turns out ultimately
that it was wrong in that it was Nishimatsu and not the Plaintiff who wrongfully
repudiated the sub-contract, still it cannot be said that the 1st Defendant's demand in
calling in the bond was fraudulent. The evidence before the court showed that the 1st
Defendant did act on the representation of Nishimatsu and there is nothing to show
that they did so with anything other than an honest belief in what was told by them by
Nishimatsu.

Unconscionability

50. In Singapore, and some jurisdictions in Australia 15 , there had been a conscious
departure from the English position by establishing that unconscionability was a
further separate ground upon which the courts would impose an injunction to prevent
a bond call.

51. In Bocotra Construction Pte Ltd & Ors v Attorney General (No.2)16, the Singapore
Court of Appeal held clearly that fraud or unconscionability are the sole criteria for
deciding whether an injunction should be granted or refused. However, a high degree
of strictness applies and mere allegations of fraud or unconscionability are insufficient
to prevent a call. However what is the meaning of 'unconscionability' remains unclear.

52. In Dauphin Offshore Engineering & trading Pte Ltd v The Private Office of HRH
Sheikh Sultan Bin Khalifa Bin Zayed Al Nahyan [2000] 1 SLR 657, the Singapore
Court of Appeal stated that:

"...it is [not] possible to define 'unconscionability' other than to give some very
broad indications such as lack of bona fides. What kind of situations would constitute
unconscionability would have to depend on the facts of each case. This is a question

15
Ground appeared in obiter comments e.g. see Hortico (Australia) Pty. Ltd v Energy Equipment Co (Australia) Pty Ltd
[1986] 2 BCL 366, per Young J.; Hughes Bros Ltd v Telede [1991] 7 BCL 210, per Cole J.
16
[1995] 2 SLR 733; see also GHL Pte Ltd v Unitrack Building Construction Pte Ltd [1999] 4 SLR 604
 - 12 -

which the court has to consider on each occasion where its jurisdiction is invoked.
There is no predetermined categorisation."

53. As a reference, Lai Kew Chai J in Raymond Construction Pte Ltd v Low Yang Tong &
Anor (Suit 1715/95, 11 July 1996, unreported) opined that:

"The concept of 'unconscionability' to me involve unfairness, as distinct from

dishonesty or fraud, or conduct of a kind so reprehensible or lacking in good faith
that a court of conscience would either restrain the party or refuse to assist the party.
Mere breaches of contract by the party in question would not by themselves be
unconscionable".

Duration of the bond

54. Where a conditional bond contains no express provision fixing the time of release, the
bond is usually released upon:

(i) the surety satisfying damages sustained by the owner in the event of a default
of the contractor;

(ii) the determination of the contract due to the insolvency of the contractors
(subject to the maximum liability stated in the bond); or

(iii) the performance of all the contractor's obligations under the contract.

55. Without an express time limit, it may be argued that the sureties' liability continues
until every single obligation of the contractor under the contract is performed, or even
continues indefinitely. However, in practice, it is rare for bonds not to include an
expiry date.

IV. WARRANTIES

Meaning

56. The term "warranty" is used in a number of contexts, i.e. it can refer to a contractual
term; a representation from which a collateral contract arises between the same parties
to an existing contract; a representation by A leading B to contract with C on certain
terms etc.

57. In the construction context, a warranty describes a contract whereby a member of the
construction chain (i.e. contractors, sub-contractors, suppliers, architects, engineers,
project managers, quantity surveyors etc) undertakes independent obligations to a
member of the finance chain (i.e. landowners, developers, funders, tenants, purchasers
etc).

58. Warranties are used widely and are often required in addition to bonds and guarantees.
 - 13 -

Functions

59. First, warranties provide the direct contractual link between the relevant parties which
the courts increasingly require to find liability. For example, a warranty provided by a
sub-contractor to the employer allows the employer to sue the sub-contractor directly
in relation to the sub-contractor's breach of the sub-contract works which form part of
the main contract works in the absence of any direct contractual relationship between
the employer and the sub-contractor whose direct contractual relationship is with the
contractor.

60. Second, to address risks arising from liquidation or insolvency in circumstances (for
example, see paragraph 68 below).

Forms of warranties

61. There are many different standard form of warranties. Examples of performance
related warranties are:

(i) Performance warranty given by nominated sub-contractor ("NSC") to the

employer in consideration of nomination. The warranty to be given by the NSC
have words to the effect that the NSC warrant in consideration of the
Employer nominating the NSC as sub-contractor for the sub-contract works
that the NSC will carry out and complete the sub-contract works in accordance
with the terms of the sub-contract; that the NSC will ensure that the sub-
contract works are fir for purpose; that the NSC will comply with the
performance specification etc; that the NSC will obtain a bond in favour of the
Employer in a specified sum etc; and

(ii) Performance warranty given by a sub-contractor to the employer in

circumstances where the contractor has agreed, in the main contract between
the employer and contractor, to procure the sub-contractor to execute a
warranty in favour of the employer. The warranty to be given by the sub-
contractor have words to the effect that the sub-contractor warrants and
undertakes to the employer that he shall execute the sub-contract works and
has carried out and will carry out each and all of the obligations, duties, and
undertakings of the sub-contractor under the sub-contract (entered into
between the contractor and sub-contractor) and that the sub-contractor
undertakes to indemnify the employer against each and every liability that the
employer may have to any person whatsoever and against any claims, demands,
proceedings, loss, damages, costs and expenses, sustained, incurred, payable by
the employer to the extent of the breach arising from the warranty by the sub-
contractor etc.

62. In addition to the above, a warranty to be given by a sub-contractor can contain some
or all of the following undertakings:

(i) carrying out and completing the works using all reasonable skill and care;

(ii) not to specify or use certain harmful materials on the works;

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(iii) before exercising any right to terminate its employment or suspend its
performance, to give a period of notice of intention to do so;

(iv) on the insolvency of the employer, to novate the contract to the funder on
request or allow the funder to "step in" and assume the employer's rights for a
certain period; and

(vi) to grant the funder an irrevocable, royalty-free licence to use drawings and
other documents prepared in connection with the contract, copyright in which
is owned by the contractor.

V. ENFORCEMENT ISSUES

Effect of ongoing dispute between the parties as to rights and obligations under
the main contract on enforceability of, for example, performance bonds

63. Enforcement issues have been discussed earlier in the context of fraud and
unconscionability in the enforcement of performance bond. Other enforcement issues
will be examined below.

64. An ongoing dispute between the parties as to rights and obligations under the main
contract does not impact a guarantor's right to payment under an unconditional
performance bond.

65. In Re Tang Kar Hung, ex parte Hong Kong Housing Society [2001] HKEC 665, the
court examined the respective rights of a guarantor and beneficiary of an unconditional
performance bond in cases where there is an ongoing dispute between the principal and
beneficiary with regard to the main construction contract. The court stated that "where
there is a dispute between the principal and the beneficiary in respect of the
underlying contract, that would have no bearing on the liability of the guarantor
under an unconditional performance bond. The rights and obligations between the
principal and the beneficiary would be finally determined at some future date when
an 'accounting' would take place between them. In turn, if the guarantor has made
payment on the performance bond, the guarantor may be indemnified by the
principal. The guarantor has no right to recover from the beneficiary of an
unconditional performance bond in the event that it is finally determined that the
beneficiary is liable to the principal under the underlying contract".

66. This judgment reiterates the general principle that the only exception to the guarantor's
obligation to pay under an unconditional performance bond is in clear cases of fraud
(see generally Edward Owen Engineering Ltd v Barclays Bank International Ltd
[19781 QB 159 (CA)). Otherwise, the obligations under the performance bond
survive, despite any disputes stemming from the underlying contract.

Effect of dispute resolution clauses on the enforceability of performance bonds

67. There has been a noticeable increase in the number of disputed bond calls in recent
years. One issue on which there is as yet little guidance from the courts is the subject
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of dispute resolution clauses in bonds and guarantees. These clauses may provide for
arbitration 17 or an expert procedure (Odebrecht v North Sea Production Co [1999] 2
A11 ER (Comm) 405) or some other method.

68. The vast majority of construction contracts provide for the resolution of disputes by
reference to arbitration. Disputes arising under bonds and guarantees are almost
invariably decided by the court since there is usually no arbitration clause in the bond.
It is therefore open to an employer to sue a guarantor in court while at the same time
arbitration against the contractor to recover the same loss. There is a risk of
inconsistent findings and wastage of costs. In a recent case, the court refused to
intervene to stay the court action pending the outcome of the arbitration (Alfred
McAlphie Construction Ltd v Unex Corpn Ltd (1994) 38 ConLR63 (CA)). By
contrast, the court has stayed actions against a guarantor and a bondsman on their
undertaking to the beneficiary employer to abide by the award of an arbitrator
appointed under the main contract (Alstom Combined Cycles Ltd v Aegon Insurance
Co (UK) Ltd (1 May 2001, unreported), Judge Seymour QC).

Use on injunctions in enforcement context

69. The separation of on demand bonds from the underlying contract inevitably opens up
the possibility of their being used unfairly against the contractor with potentially
catastrophic consequences (See, eg Chiemgauer v New Millennium Experience
Company Ltd [2001] CILL 1741, Geoffrey Vos QC).

70. The most effective remedy for the contractor in this context is an injunction restraining
the issuing bank from honouring a demand. Normally, an applicant for an injunction
has to show three things: that there is a serious issue to be tried (ie that there is a cause
of action), that damages would not he an adequate remedy and that, on a balance of
convenience, it would cause less harm to grant the injunction than to preserve the
status quo (American Cyanamid v Ethicon [1975] 1 All ER 504).

71. These principles do not apply to on demand bonds since the courts have chosen to
equate them with letters of credit which, as autonomous obligations, must be honoured
unless it can be shown that the demand was fraudulent (Edward Oven Engineering v
Barclays Bank International [19781 QB 159, [1978] 1 All ER 976, CA).

72. This test has recently been refined by the Court of Appeal, matching the appropriate
relief against the strength of the evidence (Balfour Beatty Civil Engineering v
Technical & General Guarantee Co Ltd (1999) 68 ConLR 180, CA. See also Sofa Ltd
v Banque du Caire [2000] Lloyd's Rep 600, CA (a case on letters of credit), and Solo
Industries UK Ltd v Canara Bank [2001] 2 Lloyd's Rep 578, CA). There are few cases
where an injunction has been granted against a bank preventing it honouring a demand
guarantee, whether on the grounds of fraud or otherwise (See, for example, Kvaerner
John Brown Ltd v Midland Bank Plc [1998] CLC 446, Cresswel1 J; Wahda Bank v
Arab Bank (16 June 1999, unreported).

17
(Moss and Marks, op cit, includes precedents with ICC arbitration clauses)