Although since 1997, Hong Kong has been a Special Administrative Region of the People’s Republic of China (PRC), the construction industry practice in relation to the use of performance bonds is similar to that in the UK: both ‘conditional’ bonds in a traditional form and instruments of an ‘on-demand’ nature are regularly used to provide employers with a necessary degree of security in the event of contractor non-performance or insolvency.
In recent years the
The use of bonds is not widespread in mainland PRC, but this position is bound to change as international business practices establish a more secure foothold in the PRC.
Types of performance bonds
There are two types of bond commonly in use in
The typical conditional bond 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.
The surety’s liability under the bond arises when there is a default on the part of the contractor and damages are sustained by the employer. The employer must prove first, breach of contract committed by the contractor and secondly, damages occasioned by the breach, before the requisite money is paid out. The Hong Kong Courts back in 1987 gave effect to the conditional nature of the traditional wording in the case of Tins Industrial v Kono Insurance [1987].
The English House of Lords applied a similar interpretation in the well-known case of Trafalgar House Construction (Regions) v General Surety and Guarantee [1996].
An on-demand bond is an unconditional bond that requires the bondsman to pay when the employer makes a ‘call’. Unlike a conditional bond, the employer is not required to prove default and damage. It is in effect a banking instrument, rather than a guarantee.
To obtain payment, the employer simply has to serve a written demand on the bondsman at the given address within the bond’s period of validity stating that the contractor has failed to perform. In the absence of fraud, and in certain jurisdictions (for example
However, in certain forms of wording, the distinction between conditional and on-demand bonds is, in many cases, far from clear. Although the traditional (some may say archaic) wording of a conditional bond is given effect by the Hong Kong courts as guarantee, there has been more room for debate with certain home-grown bespoke forms of bond where the interpretation is less clear.
For example, in the Hong Kong case of Airport Authority of Hong Kong v American Home Assurance Co [2000], the bond in question provides that “the bondsman shall upon demand made by the employer in writing and without proof of the said default or conditions satisfy and discharge the amount identified in the demand of any damages sustained by the employer by reason of the default up to the amount of the bonded sum”. The Hong Kong High Court held that the bond was an on-demand bond.
A contrasting case is Dragages et Travaux Publics (Hong Kong) v Citystate Insurance [2001], where the bond in question provides that: “In the event of default by the sub-contractor of any of its obligations under the sub-contract and upon demand in writing made by the main contractor upon the surety, the surety shall satisfy and discharge any claims, actions, damages, losses, charges, costs or expenses whether directly or indirectly sustained thereby by the main contractor up to an aggregate of the bonded sum.”
Although the words ‘on-demand’ were used, the Hong Kong Court of Appeal held that the bond was a conditional bond as the wording of the bond was not clear enough to constitute an on-demand bond. This indicates that employers and their advisers should approach the drafting of bonds with considerable care.
Enforcement difficulties
As in the English jurisdiction, the usual difficulty arising in
There are also a number of procedural complications arising from enforcement which sureties may use to resist or postpone payment. First, some forms of bond may contain an early release date, for example upon practical completion of the works. In respect of default by a contractor occurring before completion, the employer should check the expiry date of the bond and ensure that a call is made before its expiry.
Further, 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.
Secondly, 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 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.
Thirdly, 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 also be resisted by employers when reviewing or approving forms of bond.
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.
Most of the standard forms of construction contracts, in
of damages under the building contract.
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 contract (Paddington Churches Housing Association v Technical and General Guarantee [1999]).
On the other hand, the wording of the bond may permit an earlier claim for damages against the surety (as in Nene Housing Society v National Westminster Bank [1980].
The
Many disputes between employers and contractors under a bond are due to the ambiguity of the terms of the bond. Careful drafting of a bond can offer substantial protection to an employer against the default or insolvency of a contractor. If the employer is concerned about the form of bond submitted by the contractor, it is preferable to specify the required form in the tender documents.
David Boyle is a partner at Johnson Stokes & Master in
