1. What are unconditional bonds?
A bond is a written promise to pay money or do an action should certain circumstances occur or a certain time elapses. In business transactions, a contractual party usually obtains a bond from a commercial bank and transfers such bond to the other party to ensure that, if there is any breach of contract, such as failure to make payment, the bank will stand in for the defaulting party in making the payment in compliance with the terms of the contract.
An unconditional bond is, exactly as it sounds, a bond that allows the beneficiary to claim the money almost without any condition (except for some minor conditions such as the requirement of a written request being submitted within the valid term of the bond, etc.). For instance, if there is an alleged breach of contract, a party can use the unconditional bond to claim the money from the bank immediately to compensate for any damages resulting from such breach. The bank shall not make any detailed enquiry or ask the party to prove the breach of contract.
Thus, an unconditional bond is almost like money itself. It is used commonly in construction. For instance, the owner usually retains about 5% – 10% of the contract value (i.e. only pays the contractor 90% – 95% of the contract value) after the construction is finished. Such retained money is to cover the expenses for rectifying any defect arising before the practical completion or during the defect liability period after the practical completion, in case the contractor fails to rectify such defect. In large construction projects, 5% – 10% of the contract value will likely be a very significant amount and retaining such amount of money may affect the business of the contractor.
Thus, an unconditional bond can be used in place of an amount of money because (i) it still gives the owner the right to claim the money immediately when necessary, and (ii) the owner does not retain the money so the contractor can use such amount of money for other business.
2. What is the problem with unconditional bonds?
As mentioned above, unconditional bonds can be of great assistance to the beneficiary in dealing with future violations of transactions. They allow the beneficiary to immediately obtain the money without having to file a lawsuit and go through time-consuming litigation proceedings; the other party will have to file a lawsuit in this case to claim back the money. In other words, it transfers the burden of filing a lawsuit from the violated party to the violating party.
Nevertheless, an unconditional bond only works if the bank keeps its promise to make the payment unconditionally under the bond. If the bank refuses to do so (e.g. to protect the alleged violating party which is usually a client of the bank), the beneficiary will be placed in a very difficult position.
In many countries, the beneficiary can file a lawsuit against the bank to easily and quickly claim back the money. The bank will have difficulty defending such a claim because the bond itself usually stipulates clearly that the bank will pay unconditionally.
However, the outcome will likely be different in a Vietnam court of law. For instance, Company A enters into a contract with Company B. As a guarantee for its performance, Company B obtains an unconditional bond from Bank C and provides such bond to Company A. The bond stipulates that Bank C will pay any sum within the limit of USD700,000 on the demand of Company A without requiring Company A to show grounds or reasons for such a demand. Following this, Company A has a dispute with Company B and requests Bank C to pay USD700,000 under the unconditional bond. Instead of honoring the bond, Bank C refuses to pay because Bank C does not have evidence from Company A to show whether Company B breached the contract with Company A or not. Such refusal of Bank C does not comply with the agreement under the bond and Company A can file a lawsuit with the court. However, under court proceedings in Vietnam, when determining the lawsuit between Company A and Bank C, the court also allows Company B to participate in the proceedings because the outcome of such a dispute will affect Company B’s liability (if Bank C loses and is required to pay the money on Company B’s behalf, Bank C can re-claim such money from Company B).
When Company B joins such proceedings, Company B will surely request the court to reject the claim of Company A on the grounds that Company B did not breach the contract and as a result, Company A has no reason to claim any amount. Then, the court will have to verify Company B’s statement and thus, have to verify whether or not there was a breach of contract committed by Company B. In the end, Company A can only claim the money after the court concludes that Company B has breached the contract.
This distinguishing characteristic of litigation in Vietnam makes the unconditional bond completely lose its “unconditional” status. It should provide Company A with the right to immediately claim the money without needing to prove the breach of contract of Company B or wait for the court to conclude such breach of contract exists. However, when Company A files a lawsuit, Company A does not possess such right and is still required to wait for the conclusion of the court that Company B has breached the contract (which may take many years in a complicated construction dispute). This is one of the unique characteristics of the Vietnamese court system, which seeks to combine all related matters into one case instead of dealing with each matter separately (i.e. the court settles both the bond dispute between Company A and Bank C and the contract dispute between Company A and Company B in a same case).
3. How to solve the above problem?
The most common way to avoid difficulties is to only accept unconditional bonds issued by reputable banks. These banks usually value their reputation and, as a result, uphold their promises under the bonds. However, this is not an absolute solution. Completely relying on the honesty of business partners is not an advisable or stable way to do business. It is always necessary to have some measures that can be taken in the event the banks do not keep their promises.
As mentioned above, the court system of Vietnam is not suitable for enforcing unconditional bonds. Thus, the most straightforward and effective solution would be to add an arbitration clause to the bonds so that if there is any dispute between the bank and the beneficiary, such dispute will be subject to arbitration instead of the court. Unlike the Vietnamese court system, arbitration usually deals with each matter separately. For instance, in the case mentioned above, if there is an arbitration clause and Company A files a lawsuit against Bank C at the Vietnam International Arbitration Center (“VIAC”), VIAC may not summon Company B to join the proceedings and Company B may have to file a separate lawsuit against Company A. Due to the separation of the two cases, Company A can then claim the money from Bank C much earlier because Company A only needs to rely on the bond to claim the money and has no need to present arguments about the construction contract with Company B (as such construction contract dispute is considered to be a different case).