Performance Bonds as Deeds
Deeds play a central role in construction and engineering projects. Many construction and engineering contracts, and similar contracts such as collateral warranties, are entered into as deeds. The primary advantage of doing so is to secure the benefit of a longer limitation period (12 years) than if the contract were not a deed (6 years). Rights under deeds therefore last longer.
Deeds also perform a special role when it comes to performance bonds. A performance bond, when issued in the form of a deed, binds the bondsman or guarantor even though there is no counterparty to the deed. Performance bonds are commonly issued with no counterparty, but the bond will name a beneficiary who is entitled to enforce the instrument. The beneficiary will be legally entitled to enforce the bond against the bondsman because the bond is in the form of a deed. If, however, there is an irregularity concerning the bond so that it does not constitute a deed, the bond will not be enforceable.
What this means is that if the formalities for executing a deed have not been followed in relation to a performance bond, it will not be legally binding. A recent case from Australia, discussed below, considered the issue of when a performance bond will (or will not) be valid if expressed to be a deed. The case is relevant to English law, as Australian law and English law are largely the same in this area.
The Formalities for Deeds
There are two simple formalities for a document to operate as a deed:
- The document must clearly indicate that it is intended to operate as a deed. This is usually done by the document stating, for example, that it is “executed as a deed”; and
- The document must be validly executed (e.g. by 2 directors, or under a company’s seal) and delivered.
Under English law, a document executed by a company is presumed to be “delivered” upon it being executed, unless a contrary intention is shown. If, however, a document is not “delivered”, it does not take effect as a deed.
Segboer v AJ Richardson Properties
In this case:
- A contractor arranged for a bank to issue an unconditional performance bond (or “guarantee”, as it was referred to) in favour of a developer as security for the contractor’s obligations under its building contract with the developer.
- The performance bond was issued by the bank as a deed. The bank kept the original of the bond. The developer was faxed a copy.
- The developer called on the bond, and (following legal proceedings) the bank paid the developer the amount demanded.
- The contractor contended that the bond was invalid, and the bank therefore had been under no obligation to pay the developer the amount demanded.
- The contractor said that the performance bond was invalid because it had not been “delivered” – the original remained with the bank. It said that the developer was not entitled to call upon the bond unless it presented the original to the bank, which of course it could not have done, as the original never left the bank.
- Among other things, the contractor argued that the faxing of the bond to the developer was meant to indicate that the bond was held in escrow, so that it would only become effective if and when the original bond was actually “delivered” to the developer.
The court rejected the contractor’s arguments, and said that the performance bond had been “delivered” to the developer, so the bond was valid and the developer was entitled to call upon it even though the developer did not possess the original bond.
The court held that there is no need for a document which purports to be a deed to be physically delivered before it is effective as a deed. “The critical question is whether the party executing the deed has evinced an intention to be bound immediately”. Here, by executing the performance bond, and placing no preconditions on when the bond would take effect, it was clear that the bank intended the bond to take effect immediately. The fact that the bond was faxed to the developer, and the original not sent to it, was irrelevant because the bank’s intention to be bound upon execution was clear.
The argument raised by the contractor in the Segboer case was somewhat ambitious, as there was no doubt that the bank intended to be bound once it had executed the performance bond. Nevertheless, the case proceeded to court and then to appeal on this very issue. To avoid this situation from arising, it is important that deeds state when “delivery” is intended to have taken place.