Bonds

The essential difference between an 'on-demand' bond and a 'default' bond is that, under an 'on-demand' bond, the employer does not have to prove default. Provided that they can show that they have complied with the conditions for 'demanding' the bond, the employer can call on it. This is not true of a default bond where the employer must prove that the conditions necessary to call on the bond have been met.

1. that a breach under the primary contract has occurred; and
2. the level of damage suffered by him/her as a consequence of the breach.

Unless the employer can prove these 2 points, the employer cannot, at that time, call on the default bond.

Under a default bond, the bondsman has the same defences available to it as the contractor has under the building contract. Therefore, any sums the contractor can set-off against the employer's claim can be taken into account by the bondsman. (See Trafalgar House Construction v General Surety Guarantee Company [1995] 3 WLR 204, HL.)

On-demand bond

An on-demand bond is an indemnity (an undertaking by one person to meet the liabilities of another) provided by the bondsman to the employer to pay a sum of money to the employer on 'demand'. The court tends to regard on-demand bonds as the equivalent of a promissory note or irrevocable letter of credit (as detailed in the Manual of Construction Agreements, Update 5, paragraph 6[54]).

A bond does not have to be labelled 'on demand' to be construed as 'on demand' in substance although the court in Dragages et Travaux Publics (Hong Kong) Limited v Citystate Insurance Limited Hong Kong SAR CA, 18 January, 2001 held that it was imperative that there should be clear and unambiguous words to establish that a bond is an on-demand bond (in Van der Merwe v IIG Capital [2007] EWHC 2631 (CH) the court held that there is a presumption that such agreements will not be on demand unless there are clear words to the contrary). Whether a bond is an on demand bond will depend on the construction of the instrument in question (see Dragages v Citystate Insurance and IIG Capital LLC v Van Der Merwe & Another [2008] EWCA Civ 542).

For example, in Edward Owen v Barclays Bank International Limited [1978] Q.B. 159, CA, there was a performance guarantee of 10% of the contract price. The guarantee was payable:

'on demand, if so stipulated, without proof or conditions. The only exception is when there is a clear fraud'.

Despite there being no evidence of default or breach of contract by the contractor, it was held that the bond could be enforced.

Where a bond is enforceable without evidence of a breach by the contractor (or where breaches are insubstantial or trivial) Lord Denning said in Edward Owen that:

'the performance guarantee then bears the colour of a discount on the [contract] price ... [which] the English supplier, if he is wise, will take into account when quoting his price for the contract'.

As an on-demand bond can be called on 'without proof or conditions' there is an inherent risk it could be called on unfairly. On receipt of a call on the bond, the bondsman will merely check to make sure that the conditions for calling on the bond are met. If they are, the bondsman is compelled to pay the full sum of the bond.

So the effect of providing an on-demand bond (rather than a default bond) is to deprive the contractor of the benefit of all the safeguards built into the contract.

Depending on the bargaining powers of the contracting parties, contractors should resist an on-demand bond.

Prohibiting a call on an on-demand bond

There are few ways in which the call on an 'on-demand' bond can be defended. Lord Denning said in Edward Owen that the court would only intervene in the event of fraud.

In TTI Team Telecom International Limited v Hutchinson 3G UK Limited [2003] All ER (Comm) 914 the court said that it would also intervene to restrain a call on an 'on demand' bond in the event of 'bad faith' on the part of the person calling on the bond. Acknowledging that it is the Singapore courts that have developed the 'bad faith' ground for intervention on a call on a bond, Judge Thornton QC said that:

'... [t]he courts will, however, only intervene where the beneficiary has acted so unfairly or with conduct that is so reprehensible or lacking in good faith that a Court of conscience would either restrain or refuse to assist the party in question.'

Without giving actual examples of each, Judge Thornton QC said that breach of faith could arise in situations such as:

1. a failure by the beneficiary to provide an essential element of the underlying contract on which the bond depends;
2. a misuse by the beneficiary of the guarantee by failing to act in accordance with the purpose for which it had been given;
3. a total failure of consideration in the underlying contract;
4. a threatened call by the beneficiary for an unconscionable ulterior motive; or
5. a lack of an honest or bona fide belief by the beneficiary that the circumstances, such as poor performance, against which the performance bond has been provided, actually exist.

On the facts of this case, there was no evidence of bad faith.

Case law suggests, therefore, that the court will grant an injunction preventing a call on an on-demand bond if at the time of the call there is clear evidence of fraud or bad faith.