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Sat 28 Feb 2009 04:00 AM

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A tempting bond of security

Omar Al Saadoon – senior associate – construction and engineering department, Al Tamimi & Company, discusses the relevance of guarantee bonds in the current market situation.

"On demand" guarantee bonds are a typical form of contractual security in the UAE construction industry, particularly on large projects.

Their use, in theory, is to afford the employer with secured funds from a surety, in the event the defaulting party does not perform according to the terms of the underlying contract, or becomes insolvent.

Given the current restrictions on liquidity, there may now be increasing pressure by employers to view a bond as an alternative source of finance, irrespective of the grounds for making a call on a bond.

The position of lenders is fraught with difficulty given that their commercial reputation may be tarnished if they refuse to pay out, particularly given their contractual or legal obligation to the employer (as primary obligor) to pay out notwithstanding any underlying contractual dispute or dispute, concerning the validity of the call upon the bond between the employer and the contractor.

Future industry trends

Given the current lack of liquidity and the prevailing "wait and see" approach now taken by stakeholders, evidenced by the fact that lenders are cautious in lending to each other forget businesses, it is possible sureties might harden their attitude to their exposure on such bonds, particularly on large construction projects and increase their due diligence on contractors procuring bonds and employers benefitting from them.

The nature of conditional bonds such as those proposed by Fidic would, for instance, require a beneficiary of such as bond to only claim for amounts which are "properly" due and further to establish a claim strictly in accordance with the contract provisions and to provide prior notice to allow the contractor to remedy a notified breach within a fixed period of time.

This possible change in the local industry is likely to shift contractual risk on to the employer. The employer will have to ensure it can be reasonably certain of its grounds for claiming and to serve proper notice to allow the contractor a period of time to remedy its breach.

This will cause the employer to "front load" its costs in the  preparation of claim (in advance of any arbitration or litigation proceedings) as well as sustaining the financial effect of any alleged breach before the surety under the bond is lawfully obliged to pay out.

Hidden danger

A contractor will try its utmost, especially in the current financial climate, to resist a call on a bond on the basis the funds paid  to the beneficiary may never be fully recovered by it, in legal proceedings, or arbitration, even if the call by the beneficiary was later ruled to have been without merit.

Conversely, the employer will seek to rely on its rights in calling upon such a bond for immediate payment because it has contracted with the contractor on this basis (in part) and that such as bond provides a source of readily available finance in the event the employer requires a bond to cure the contractor's breach.

A frustration of an employer's call in the form of the contractor seeking temporary relief by way of attachment or injunction type proceedings can have potentially serious financial consequences for the project as a whole (implicit in this is the survival of the protagonists).

Temporary relief?

Given that lenders usually have to act promptly in complying with a call upon a bond (typically made before any formal dispute has commenced) contractors have to act very fast in trying to prevent the lender from paying out to a beneficiary of a bond.

Regardless if formal arbitration proceedings have commenced, it is unlikely the contractor will have sufficient time to obtain the relief sought from an arbitral tribunal on the basis that it takes time for a tribunal to be appointed or for a tribunal (once appointed) to convene to consider the application for relief.

The attractiveness of immediate resort to the local courts is therefore heightened.

In respect of trying to prevent a surety paying out pursuant to a call on a bond, a contractor would generally have to satisfy an arbitral tribunal or local court that:

The amounts claimed are disproportionate to the current amount being guaranteed under the bond or the claim was evidently fraudulent or there was demonstrable bad faith.

Conclusion

Disputes over entitlement to cash under these bonds may be viewed as a large ripple to an impending wave of more formal and high value disputes, as disputes over bonds and the underlying contracts are inextricably linked.

The timing involved in making and resisting a claim on such bonds and the legal forums in pursuing such claims relating to bonds will all be critical.

If you would like to write for
Construction Weekin this column, please email
rob.wagner@itp.com.

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