Security in the form of guarantees (or bonds) is common practice in construction projects. With contractors, sub-contractors, suppliers and even consultants being required to provide some or all of tender, performance, advance payment, supply, maintenance and retention securities.
A guarantee is an irrevocable commitment, by the bank of the party obliged to provide the guarantee (e.g. contractor), to pay out the committed sum to the beneficiary (e.g. employer) in the event the terms of the guarantee are met.
Guarantees are either conditional or unconditional (also known as "on-demand"). On-demand guarantees usually require nothing more than a written request (or "call") from the beneficiary to the bank with a bare assertion that the event against which the guarantee was to protect has occurred. I.e. in the case of a performance guarantee - an assertion that the contractor has failed to perform as he should. The bank is obliged to pay out.
Conditional guarantees usually require that the bank is provided proof of the contractor's failure to meet its performance obligations before it will pay out. This is clearly much better for the contractor but the acceptance of conditional guarantees in Qatar is rare; on-demand guarantees are the norm.
Once a bank has paid out under a guarantee it usually demands the immediate repayment of the sum by contractor. The Bank typically converts the demand to a credit facility by way of overdraft or loan on unfavourable terms.
A call on a guarantee can have a devastating impact on cashflow, affect the ability to obtain credit facilities or guarantees in the future and reduce credibility (tenderers are often required to disclose if they have ever been subject to a guarantee call).
A surprising amount of calls on guarantees are made in circumstances where the guarantee should have ended or been reduced (this is usually the process with advance payment guarantees as the advance payment is "repaid" on a monthly basis). Other problems occur where the beneficiary has tendered the guarantee to a third party as security for a debt or facility of their own. This is because it remains the case that sometimes the physical original copy of the guarantee must be returned to the bank in order to cancel it.
To protect yourself (as far as possible) when providing an on-demand guarantee:
- Include a definite expiry date. Do not leave the guarantee open for an indefinite period or link it to the provision of a certificate as you risk losing any control over its expiry or cancellation.
- Prohibit assignment of the guarantee.
- Require an indemnity from the beneficiary against a wrongful call (there is one in a standard form FIDIC contract if not removed). This should at least mean that the beneficiary thinks twice before making a call on the bond without justifiable contractual basis.
- Talk to the bank if there is a risk of a call and ask it to notify you in the event of a call. This may allow you to negotiate with the beneficiary or at least to start to put in place contingencies for the event.
- Consider obtaining an injunction from the local court if you think you are at risk of a wrongful call - but be aware that these are rarely successful.