Legally Bound

Jordan ... bonds are “crisis tools”.

Jordan ... bonds are “crisis tools”.

Default bonds examined

STUART JORDAN* highlights the importance of improving clarity in a bond while considering what will and will not trigger a valid call on a bond, citing the example of a ruling in a UK court case.

June 2020

Why do we keep seeing new disputes about bonds in construction projects? Bonds are both familiar and straightforward. These short and simple financial instruments are part of almost every project in the Gulf region. And yet, we keep finding new things to argue about. In truth, the argument is usually a new angle of the everlasting question: should a bond provider pay out on a call from the beneficiary? A recent dispute examined a common form of bond:

A main contractor (Multiplex Construction Europe Limited) engaged a subcontractor (Yuanda (UK) Company Limited) on a major construction project. As required under the subcontract, Yuanda procured a bond (from the Australia and New Zealand Banking Group) as security against its performance.

The subcontract works fell into delay, the responsibility for which was a matter of dispute between the parties and a statutory adjudication on this issue was commenced.

While the adjudication was ongoing, Multiplex decided to make a call on the bond, at which Yuanda applied for an injunction against Multiplex, to stop them proceeding with the call; and against the bank, to stop them paying out. The injunction was initially granted and the dispute came to the Technology and Construction Court in England, on Yuanda’s application for extension of the injunction.

The judge decided to extend the injunction because Multiplex had not met the requirements for a successful call. Under its terms, the bond would trigger only if Yuanda had breached the subcontract and damages had been sustained by Multiplex “as established and ascertained pursuant to and in accordance with the Contract and taking account of all sums due or to become due to the Contractor”.

In other words, this bond was a default bond; and both the alleged breach and the question of damages had not been established and ascertained at the time when Multiplex made the call on the bond.

For me, the more interesting points were about the arguments that the judge rejected from both parties about what “established and ascertained” means. And this interest is magnified by the fact that the bond was based on the ABI Model Form of Guarantee Bond, which is very widely used.

First, Yuanda cited the “taking into account of all sums due or to become due to the Contractor” to argue that the bond could not be called at all until the final account was settled and final net liability had been calculated. Given that the bond was to expire shortly after the end of the defects correction period, the entire purpose of the bond would have been lost.

On the other side, Multiplex argued that the breach and damages had already been ascertained through their own calculations and certifications of the same to Yuanda, as a matter of contract administration.

The judge rejected both arguments and said that the breach and the damages would be “established and ascertained” for bond call purposes if Multiplex were to obtain an adjudicator’s award to that effect. The logic of that decision is clear enough since such an award would be immediately enforceable, regardless of other counterclaims and set-offs which might appear in the final account. But enforceability of statutory adjudication awards is a peculiar feature of English policy; and Yuanda’s argument might have more success in other countries.

The judge rejected Multiplex’s argument because the subcontract did not have provision for a third-party certifier or decision-maker, required to decide these issues fairly. The breach and damages were, therefore, not established and ascertained simply by Multiplex saying so. Again, the obvious question is whether the Multiplex argument would, therefore, succeed in the context of a conventional main contract administered by an engineer or employer’s representative (usually a third party) who has an express obligation to determine such issues fairly. Fidic is the prime example.  

So, it is arguable that this bond, in a different jurisdiction or with a different underlying contract, could have produced polar opposite results, namely:

1. It could not be called at all until settlement of the final account; or

2. It could be called as soon as the engineer certifies money as owing from the contractor.

Disputes will continue to crop up in this area. Bonds are “crisis tools”; so, by their nature, they are going to be used when the project is under stress and parties are going to fight their corner.

So the lesson, as usual, is about clarity – in this case, on what will and will not trigger a valid call. And in looking at the terms of the bond, we need to take into account its governing law, which often (on Gulf projects) will be from East Asian banks.

 

* Stuart Jordan is a partner in the Global Projects group of Baker Botts, a leading international law firm. Jordan’s practice focuses on the oil, gas, power, transport, petrochemical, nuclear and construction industries. He has extensive experience in the Middle East, Russia and the UK.




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