Hong Kong: Performance Bonds - Important Legal Considerations

Co-written by Chik Wing Hong

Insurance companies and banks frequently act as sureties for the provision of performance bonds required in the construction industry. A typical scenario is as follows:-

(A) Prior to the issue of the Bond

1. Consider very carefully the wording you are asked to provide. Wherever possible, ensure that the bond is a conditional one. In other words, make sure that the party who wishes to call upon the bond has to demonstrate firstly that there has been an event of default entitling him to call on it and secondly that he must prove the amount to which he is entitled under the bond.

Unconditional Bonds can cause considerable headaches for their providers since they are almost always payable on demand.

2. Ensure you have appropriate counter security. It is usually possible to obtain counter guarantees from corporate entities connected with the subcontractor on whose behalf the bond has been provided and individuals, e.g. Directors of the subcontractor. Such counter guarantees not only provide the bond holder with a measure of protection but can provide useful leverage to ensure the co-operation of the subcontractor. This can be crucial in reducing as far as possible the amount of the claim under the bond or in demonstrating that there has not been a "default". If an individual has provided counter security it is in his interests to ensure that it is called upon by the bond holder to the smallest extent possible if he is to minimise the risk of personal bankruptcy.

The wording of any counter guarantees which are obtained merits careful consideration. They should be worded so as to ensure they are payable on demand and you are not required to demonstrate default or quantum. They should cover the costs of defending a claim under the bond and of seeking recovery under the counter guarantees.

(B) When the Bond is called on

1. Consider whether the bond is conditional or unconditional. If it is conditional, move as quickly as possible to obtain as much information as possible from the main contractor and the subcontractor to enable you to evaluate the strength and size of the claimant’s claims. In some cases the subcontractor may go into liquidation/bankruptcy. If this happens it is likely to be far more difficult to obtain information and documents as communication will usually be through the receiver/administrator of the liquidated company and many of those concerned in the building project may prove unco-operative.
2. Where the bond is conditional the burden of proof is on the party claiming under it to demonstrate its entitlement to claim and the amount it is entitled to claim.
3. Consider carefully how to ensure that you are in a position to obtain reimbursement from your counter guarantors as quickly as possible after you have become liable to pay under the bond. Consider joining the counter guarantors as third parties to any proceedings commenced by the claimant against the bond provider and the possibility of obtaining summary judgment against the counter guarantors. The threat of proceedings against them may help you to persuade them to co-operate with you in defending the claim against you under the bond.
4. Where entitlement to claim under the bond is in dispute, consider the possibility of persuading the subcontractor to take over the defence of the action against the bond holder.

Claims against Performance Bonds are often sizeable. They require careful handling if the bond provider is to ensure his rights are protected and his exposure minimised.