All jokes aside, a recent case in the Court of Appeal has confirmed that demands made under an on-demand performance bond remain valid even if there are questions as to whether the person calling the bond is entitled to the money claimed.

The case highlights once again the autonomous nature of on-demand bonds and their independence from disputes arising out of the underlying contract. Therefore, parties to construction contracts should be clear whether it is an on-demand bond (payable immediately without enquiry) or a performance guarantee (payable in accordance with certain conditions relating to the main contract) which is required in order to protect against default or non-payment.

In the case (Wuhan v Emporiki Bank) a document referred to as a “payment guarantee” had been issued by the bank as security for the payment of the second instalment of the contract price for the construction of bulk carrier ships. The payment guarantee stated that the bank irrevocably, absolutely and unconditionally guaranteed the due and punctual payment of the second instalment in the event that the purchaser failed to pay for a period of 20 days after the instalment fell due.

Following a period of dispute between the purchaser and the contractor over whether the second instalment had fallen due, the contractor shipbuilder submitted a demand to the bank for payment under the payment guarantee. The bank declined to pay, arguing that it was not clear that the second instalment was in fact due.

The contractor commenced proceedings against the bank for non-payment. In a previous hearing the Court of Appeal confirmed that the bank was in default. The court decided that the wording of the payment guarantee made it an on-demand bond and the only scenario in which payment under an on-demand bond could be resisted was where the demand was presented in an invalid form or in the clear case of fraud. As neither case applied, the bank was obliged to pay the sum to the contractor without delay.

Following the earlier hearing, and subsequent payment by the bank to the contractor, the arbitration tribunal dealing with the underlying contractual dispute made a binding award that the second instalment had not in fact fallen due. Perhaps partly encouraged by postscript comments made by the judge in the original hearing, the bank returned to the Court of Appeal and asked the court to declare that the sum paid to the contractor be held on trust either for the bank or for the purchaser as the contractor knew that it was not entitled to the money.

In rejecting this notion, the Court of Appeal described such an argument as a “heretical proposition which, if accepted, would be subversive of the basis upon which international trade is routinely financed”. That is a pretty strong “no”. The court concluded that monies paid out under an on-demand bond could never be subject to a trust in this way, reiterating that on-demand bonds are independent contracts containing obligations that are entirely separate to the position between the parties under the underlying contract. The bank, on receiving a valid demand was obliged to pay the claimed sum immediately without question or enquiry. It was irrelevant whether the presenter of such demand was, in fact, entitled to the sum.

Part of the problem with bonds, and one highlighted by this case, is the often loose use of terminology. In this case the document issued by the bank was called a “payment guarantee” but, on analysis, the actual wording of the document made it an on demand bond. This reemphasises the point that many in the construction industry often get wrong: it is not sufficient to read what it says on the front of the document (be that “performance bond”, “performance guarantee”, “guarantee bond”, “letter of guarantee”, “on-demand bond” etc.) but it is always essential to read the document in full to understand what it actually does.