PLC Construction blog: JCT bonds: on demand instruments or guarantees?

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Summary: Allow me to set the scene. Our client, Q, is procuring a major office development in the City of London. Q tells me that, in order to secure the most competitive tenders for the project, he has decided to give the contractor advance payments and payments for off-site goods and materials. Fairly standard practice, particularly in this market. Q goes on to explain that these payments will be bonded using the JCT standard forms of advance payment and off-site goods and materials bond (the “JCT bonds”) because they are on demand and as good as money in the bank, aren’t they?

Allow me to set the scene. Our client, Q, is procuring a major office development in the City of London. Q tells me that, in order to secure the most competitive tenders for the project, he has decided to give the contractor advance payments and payments for off-site goods and materials. Fairly standard practice, particularly in this market. Q goes on to explain that these payments will be bonded using the JCT standard forms of advance payment and off-site goods and materials bond (the “JCT bonds”) because they are on demand and as good as money in the bank, aren’t they?

Certainly the context in which the JCT bonds are used - a bond provided in respect of an advance payment or a payment for off-site goods and materials will typically be required to be on demand - and their frequent use without amendment suggests a majority view that they are on demand. However, my view, given recent case law, is that a court may just as easily be persuaded to interpret the JCT bonds as contracts of guarantee.

The Marubeni presumption and previous case law

Why do I think this? First, there is a strong presumption against an instrument being interpreted as on demand where it is given outside a commercial banking context (see Marubeni Hong Kong & South China Ltd v Ministry of Finance of Mongolia). The JCT bonds will almost always be given outside such a context.

Second, there have been a number of cases where instruments containing a combination of bond and guarantee wording have been interpreted by the courts to be guarantees rather than on demand instruments, even though the parties to the underlying contract clearly intended them to be the latter. The JCT bonds both contain a reference to “this Deed of Guarantee” and contain guarantee type language – for example, “indulgence” wording that preserves liability in circumstances where a guarantor would otherwise be discharged (including, where the underlying contract is modified or changed or an extension of time is granted to the contractor). In addition, they contain a form of notice that refers to the quantum of the contractor’s default (which hints at conditionality and co-extensiveness, both of which are at odds with the concept of primary liability).

Paget’s presumptions

In the recent case of Wuhan Guoyu Logistics Group Co Ltd and another v Emporiki Bank of Greece SA, the Court of Appeal reversed the first instance decision that a security instrument containing a combination of bond and guarantee wording was a guarantee rather than an on demand bond. Interpreting the instrument as an on-demand bond, the Court of Appeal adopted the presumption set out in Paget’s Law of Banking that:

“Where an instrument (i) relates to an underlying transaction between the parties in different jurisdictions, (ii) is issued by a bank, (iii) contains an undertaking to pay ‘on demand’ (with or without the words ‘first’ and/or ‘written’) and (iv) does not contain clauses excluding or limiting the defences available to a guarantor, it will almost always be construed as a demand guarantee.”

The court upheld previous authority which indicated that the fourth element may not be an essential component of the presumption: an instrument can still be on demand even if it contains “indulgence” wording. However, the inclusion of such “indulgence” wording still increases the risk that a court will interpret the instrument as a guarantee if, for example, one or more of the other elements of Paget’s presumption are absent. Indeed, the court commented that “…everything must in the end depend upon the words actually used by the parties”. Also, we shouldn’t forget the comments of the court in Vossloh Aktiengesellschaft v Alpha Trains (UK) Ltd that:

“Whether a particular contract of suretyship is of the one kind or the other or, indeed, a combination of the two turns on its true construction. A contract which contains a provision preserving liability in circumstances where a guarantor would otherwise be discharged …will usually indicate that the contract is one of guarantee because such a provision would be unnecessary if the contract were one of indemnity.”

A practical solution

At best, the guarantee type language contained in the JCT bonds is unnecessary; at worst, it could lead to them being construed as something other than on-demand instruments. For this reason, and notwithstanding the recent decision in Wuhan, my recommendation to Q was that he delete the “guarantee” type wording from the JCT bonds. It is worth noting that this change was accepted, without issue, by the contractor’s bond providers. Perhaps it is time for the JCT drafting committee to take another look at their bond wording.

This blog first appeared on PLC Construction on 16 January 2013, as part of our regular construction blog series in which we share our practical experiences of working in construction and engineering and give our opinion on the current and future legal developments that shape and will shape the industry. Please select the link for other PLC Construction blogs.

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