“Experience shows that employers are keen on assuming that the guarantee held by them is on-demand, where in reality it might not be.”

Performance guarantees: practical experience in the UAE

This article covers the nature and type of performance guarantees commonly used in the construction industry in the United Arab Emirates. It gives guidance on how to interpret the nature of guarantees and avoid practical difficulties faced by employers when calling on performance guarantees in the UAE. The article also deals with the contractor’s option to seek preservatory attachment orders from UAE Courts, stopping the guarantor, usually banks, from releasing any funds to the employer. It also details the wide discretion granted to the Courts by UAE law in exercising this discretion; and how such discretion creates extreme uncertainty in this area of law.

The use of all major standard forms of construction contracts requires contractors to issue a performance guarantee to the employer for the purpose of securing, to a certain extent, the performance of the contracted works. In most cases, contractors procure performance guarantees from local banks in the form of a letter of guarantee.

The bank issues a written undertaking to pay a specified sum of money to the employer in the event of non-performance of contracted works by the contractor. Customarily, performance guarantees are issued for the amount of ten percent of the value of the underlying contract.

Types of performance guarantees

There are typically two types of performance guarantees: on-demand and conditional.

Payment under a conditional performance guarantee is subject to the fulfilment of the conditions set out in the guarantee itself. Common conditions may include: (i) following certain procedures when calling upon the guarantee; or (ii) providing proof of the contractor’s breach and non-performance of contracted works; or (iii) furnishing of evidence of the amount of resulting damages. This evidence can be provided in the form of a final judgment from the courts or a final arbitral award.

The liability of the bank to release payment to the employer is not triggered until all conditions set out under the conditional performance guarantee are duly fulfilled.  

By contrast, if a performance guarantee does not set out any conditions precedent to the bank’s obligation of payment, the guarantee will be on-demand in nature. Calling upon an on-demand guarantee creates an immediate obligation on the bank to release payment of the demanded amount upon the employer’s first, often written, request for payment.

Practical considerations and experience

Practical experience shows that employers are keen on assuming that the guarantee held by them is on-demand, where in reality it might not be.

It can be due to the fact that when the guarantee was originally issued by the bank upon the contractor’s request, the wording of the guarantee was not drafted properly; or the intention of the parties was not clear to each other.  For instance, the employer might be under the impression that the contractor has agreed to give an on-demand guarantee, whereas the contractor’s intention was more precautious and it wanted to provide a conditional guarantee.

The above example is in fact quite rare because mostly it is the employer who provides the wording of the guarantee to the contractor, who in turn provides it to the bank. Therefore, it might be safe to say that it is the employer himself, who can be blamed for poor or hasty drafting of the guarantee, which the employer believed would be swift and easy to call upon, but the ambiguity and conditions made the employer’s reality quite different from its expectations when the time to call the guarantee to arise.

Therefore, first of all, hasty and poor drafting may leave the nature of the guarantee ambiguous.

Secondly, employers should carefully construe the wording of the guarantee in hand before they call upon it. The wording of a performance guarantee is the predominant determining factor of the nature of banks or any other guarantor’s liability. Being a contractual undertaking, interpretation of the bank’s obligation underperformance guarantees will be subject to the normal rules of interpretation provided under the UAE Civil Transactions Law.

Therefore, the employer must ensure from the very beginning that all conditions set out in the guarantee are properly and duly fulfilled before a request is made to the bank to release the payment. Otherwise, the bank may refuse to release payment and the employer will end up being in a lengthy judicial battle with the bank and the employer.

The advantage of performance guarantees is to give the employer immediate access to the guaranteed funds to rectify or complete construction works in the event the Contractor fails to perform the works or performs it defectively.

However, due to the above mistakes, the purpose and advantage of performance guarantees can be entirely defeated.

As mentioned, experience shows that employers in UAE are very quick to assume that the performance guarantee is unconditional whereas in reality the objective interpretation of the wording of the guarantee could be otherwise obscure or even expressly subjected to satisfaction of certain conditions.

As a result, guarantees become a cause of dispute between the guarantor and employer. Such disputes not only defeat the whole purpose of the guarantee i.e. immediate access to funds; these disputes are counter-effective because they lead to expensive and lengthy legal battles.

The later section of this article provides some hints and clues in relation to how the nature of the guarantee can be determined in specific circumstances:

A guarantee is likely to be on-demand if it includes wording like:

  1. upon your first written demand’
  2. ‘notwithstanding any disputes pending before any court, arbitral tribunal or other authority’
  3. ‘without exception or objection’
  4. without any further proof or conditions and without any right of deduction, set-off or counterclaim’

If the guarantee is on-demand, the bank’s obligation will trigger the employer’s first demand. If the bank fails to release payment, then the employer will have an independent cause of action against the bank.

Even an on-demand guarantee may at the least require that the call is made in writing and a statement is made that the contractor has breached the underlying contract although with providing proof of that breach. Secondary to the wording of the bond is the approach and attitude of the courts of the governing jurisdiction. By way of example, English courts are adamant on requiring proof of default by the contractor. English Courts construe on-demand guarantees very narrowly.

Legal nature of guarantees issued by banks in the UAE

Performance guarantees issued in the form of bank guarantees are governed by Articles 411 to 419 of the UAE Commercial Transactions Law (“CTL”).

According to Article 414 of the CTL, performance guarantees issued in the form of bank guarantees will be prima facie construed as unconditional on-demand guarantees, unless the Employer’s entitlement is made dependent on the satisfaction of express conditions set out under the letter of guarantee.

The law in this respect is settled in UAE, that performance guarantees issued by banks create an independent contract between the bank and the employer, which is separate from the underlying contract between the contractor and the employer. The liability of the guarantor is primary and the Contractor is not privy to this contractual relationship.

The prima facie on-demand nature of bank guarantees is also confirmed under Article 417 of CTL, which provides ‘The bank may not refuse payment to the beneficiary on grounds concerning the bank’s relationship with the person making the order or the relationship of the latter with the beneficiary.’

As a result, the employer has a direct course of action against the bank who does not honor this contractual obligation without justifiable excuse.

TIME OF PAYMENT

There has been no time limit prescribed under the laws of UAE for the bank to release payment post invocation of the guarantee. Timing will be governed by the terms of the guarantee and the bank will have to comply with that time limit. Therefore it is between all the parties involved to decide the time limit for making payments under the guarantee upon its invocation.

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