On demand or guarantee? A reminder of the basics

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Summary: Distinguishing an on demand bond from a performance guarantee can be a tricky business. So a restatement of the principles by the Commercial Court in July in Caterpillar Moteren GMBH & Co K.G v Mutual Benefits Assurance Company [2015] was a welcome reminder of the care which needs to be taken to ensure a bond truly meets the “on demand” criteria.

Distinguishing an on demand bond from a performance guarantee can be a tricky business. So a restatement of the principles by the Commercial Court in July in Caterpillar Moteren GMBH & Co K.G v Mutual Benefits Assurance Company [2015] was a welcome reminder of the care which needs to be taken to ensure a bond truly meets the “on demand” criteria.

Caterpillar, entered into two subcontracts with International Construction & Engineering Inc (ICE) for the provision of services in connection with two power plants. Under each subcontract, ICE provided an advance payment bond and a performance bond  issued by the defendant, Mutual Benefits Assurance Company (MBAC). Problems arose and Caterpillar made a call under the bonds. MBAC refused to honour the call.

Caterpillar applied for summary judgment, arguing that the bonds were “on demand” bonds. MBAC asserted that they were guarantees, and that it was only liable to pay the sums due if Caterpillar could establish that ICE was liable, either by means of an arbitral award or by concession.

The Court held in favour of Caterpillar, ruling that the bonds were “on demand”. It confirmed the approach taken in Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA [2012]. In doing so, it focussed on the wording of the instrument in question and whether the four factors identified in Paget's presumption (from Paget’s Law of Banking) are present, namely:

  • Does the instrument relate to an underlying transaction between parties in different jurisdictions?
  • Has the instrument been issued by a bank?
  • Does the instrument contain an undertaking to pay “on demand” (with or without the words “first” and/or “written”)?
  • Does the instrument NOT contain clauses excluding or limiting the defences available to a guarantor?

If the instrument meets all the above criteria there will be a presumption that it is “on demand”.

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