Italy: Performance Bond: Obligations Of The Bank In Case Of Calling

The Performance Bond is an autonomous guarantee at first demand which is issued by the guarantor upon instructions of a subject (for example, the seller or the contractor, so-called 'applicant') based on a contract stipulated between the guarantor and the applicant.

The applicant submits the request to issue the bond according to the conditions of the underlying contract stipulated between the seller/contractor and purchaser/owner and to secure the due performance in favour of the latter.

We have analyzed in other articles the main characters of the Performance Bond, but it must be emphasized here that it is a guarantee substantially independent from the underlying contract (in our example, the sales or works contract) and that it can be paid on the basis of a simple demand that the purchaser will send to the guarantor.

Although in Italy often (in our opinion with superficiality) it is simply defined as 'on-demand guarantee', the performance bond must be more correctly defined as autonomous and on-demand guarantee.

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As mentioned:

the performance bond is issued on the basis of a contract

between the seller/contractor (the applicant) stipulates with the guarantor

(usually its bank).

It is precisely from this contract (separate and independent from the sale or works contract) that a series of obligations arise for the guarantor, especially during the calling process.

Compliance with these obligations often makes it possible to obtain that the bank refrains from the requested payment (because the calling is abusive or fraudulent).

1. Obligations of the bank during the issue of the bond

In every contract between a client and a bank, it is essential to take into account the level of knowledge that the client may have in relation to that particular contract and his experience in the related sector.

In case of request for the issue of performance bond, the bank is deemed to have not specific obligations to inform and 'instruct' the applicant about the risks associated with the issue of this type of guarantee.

It is assumed, indeed, that the purchaser/contractor is an entrepreneur capable of assessing and understanding the risks that may arise from the issue of this guarantee.

Nonetheless, the bank has a general duty to verify at least that, the seller/contractor actually is well aware of the associated risks. It is clear that, the bank cannot avoid to explain in details, for example, the differences between on-demand bond and surety if it is the first international transaction that the applicant stipulate.

We know that in case of issue of a performance bond (or other autonomous guarantee), the bank usually grants a credit facility to the applicant.

In the event the bond is called and paid, the bank will off set the amount paid to the beneficiary of the bond against the credit facility by exercising the 'right of recourse'.

2. Obligations of the bank in case of calling of the bond

In the case the bond is called, there are two types of bank obligations:

• obligation to promptly inform the applicant about the calling;
• obligation to verify if the calling is abusive.

Let's see better what we are talking about and how these obligations work in practice.

• OBLIGATION OF THE BANK TO INFORM THE APPLICANT ABOUT THE CALLING

Although the banks try to limit such obligation, it is substantially out of the question that, the bank-guarantor must inform the applicant as soon as it receives the demand calling the bond.

This is based on various reasons, but the main ones are that:

• the bank must fulfil the contract with the applicant complying with the required diligence which does not cease for the sole fact that the bank has undertaken to pay a certain amount 'at first demand';
• only the applicant can provide the bank with necessary details to prove that the calling is abusive and obliging the bank to refrain from the payment.

As mentioned above, the banks often try to limit its obligation to inform the applicant by including in the contracts the standard clauses such as:

'the bank will pay at first demand,

without obligation to provide the applicant with prior information.'

It must be kept in mind, as a further proof of what has been said, that the Uniform Rules of the ICC (International Chamber of Commerce ICC Rules no. 758) expressly provide that, as soon as the calling letter is received, the bank is obliged to inform the applicant thereof.

• OBLIGATION OF THE BANK TO VERIFY IF THE CALLING IS ABUSIVE

In this respect, there is no doubt that the bank, before proceeding with the payment, must verify (even if within certain limits) that the calling is not abusive. On this point, see also our article on abusive calling of a performance bond.

If the guarantor genuinely believes that the calling is abusive, then the guarantor has the right/duty not to pay the called amount.

As already mentioned, the calling is abusive or fraudulent when:

• the conditions for calling the bond, as indicated in the text of the performance bond, were not met; or
• the contract has been correctly fulfilled.

The calling must comply with the terms and conditions provided by the bond (for example, within the expiry date, by attaching any document that is required by the bond, with the transmission mode indicated in the bond - SWIFT message, by courier, by hand etc.). These conditions are easily detectible by the bank itself when it receives the demand letter.

At the same time, the calling is unlawful if the contract has been duly and timely fulfilled. In fact once the underlying contract has been fulfilled (except for rare cases), the bond has no longer any reason to exist and therefore any calling is contrary to law.

Also in this case, the bank will have to reject any calling but only if and to the extent that the guarantor has been put in the condition of being able to verify that the underlying contract has been correctly fulfilled.

In other words, the guarantor does not have any obligations to make its own searches to verify whether the underlying contract has been fulfilled, but once it has been informed (by the applicant) that the calling is unlawful then the guarantor must ascertain, in its opinion, whether the calling is unlawful.

This is the reason why, in case of calling or imminent calling, we suggest informing immediately the bank-guarantor to make it aware of all those facts (by attaching documents) that prove the abusive calling of the bond.

3. What to do if the bank fails to comply with its obligations

We said that once the bank has paid the performance bond, it has the right of recourse against the applicant (the seller/contractor) and to ask the prompt reimbursement of any amount paid.

Such operation is almost automatic, considering that the bank grants a credit line to the applicant against the issue of the bond. In this was, in fact, the bank will simply debit the amount of the bond which was previously made available to the applicant.

The applicant is entitled to object the bank's request for reimbursement

if the bank has paid the bond

in breach of its obligations towards the applicant itself.

In another article we have suggested what to do in case of abusive calling of a performance bond, and underlined that, in order to prevent the bank from paying the bond, it is advisable to send a warning letter to the bank and, in case it is ignored, submit an application to the competent Court to obtain an order that instructs the bank not to pay.

Also in this case (as seen above), the bank can try to limit its obligations towards the applicant by including into the contract the standard clauses such as:

the applicant waives in advance any right to apply to any competent Tribunal

that could order the bank not to pay the bond

or even clause according to which the applicant undertakes to reimburse the bank any amount paid by the same

despite any Court's order that instructs the bank not to pay.

These clauses must be considered as invalid  because they limit the defence rights of the applicant and (in the case of the last example) because they would be in breach of any interim order issue by a competent Court.

Therefore, in the event that the bank does not comply with its obligations towards the applicant, it will be necessary to start all the necessary actions to prevent the bank from debiting on the applicant's account the amounts paid to the beneficiary (in breach of the obligations provided by the mandate contract).

In the presence of the above clauses aimed at limiting the rights of the applicant, it will be possible to leverage on their invalidity.

4. Conclusion

It is often supposed that the bond calling is a matter only between the purchaser/seller or the owner/contractor. It is overlooked that the bank which issued the bond has also obligations towards the applicant by virtue of the specific contract that the bank stipulates with its client.

Precisely, this contract and the obligations contained therein are essential to prevent the supplier/contractor from suffering unfair losses in case of the bond calling.

The applicant which instructs its bank to issue a performance bond should therefore always consider that the bank must comply with its obligations and that such compliance will guarantee the applicant better protection in case of the abusive bond calling.