Overseas construction and engineering contractors are often subject to abuse from the employer (i.e., the owner), especially if it is a public agency in a third world country, as regards the unfair calls on the unconditional first demand letters of credit known as performance bonds, the issuance of which is often requested from the contractor as a pre-condition in order to get the job.
Various questions have been raised on many occasions in the Italian Courts with regard to the position of performance bonds in our legal system and to the rules relating to such guarantees, in particular with regards to as concerns the limits within which their effectiveness can be suspended by means of provisional remedies granted by Courts to the contractor. Without going into too much detail, we should like to point out that an interesting and authoritative model clause has recently been drafted and publicised by the International Bar Association, Section on Business Law, Committee T. The provisions of such model clause, which are largely based upon the new Pre-arbitral Referee procedure recently implemented by the International Chamber of Commerce in Paris, are aimed at avoiding the kind of abuse referred to above, and are to be submitted to the attention of the parties who enter into this type of contract.
The model clause provides that the performance guarantee is conditional and subject to opposition of the contractor who has carried out the project.
If the contractor objects, and the employer provides a counter-guarantee from the employer's bank entitling the contractor to be repaid if and when an IIC pre-arbitral referee decides in the contractor's favour, the employer is promptly paid by the contractor's bank pursuant to the performance guarantee. Note that this aspect of the performance guarantee provides for the payment to the employer under the performance guarantee as soon as the counter-guarantee is posted. It is any repayment to the contractor which awaits the outcome of the pre-arbitral referee's decision. So, even though the contractor has objected, the employer receives the payment in a very short time, as would have been the case had it had the benefit of an irrevocable unconditional demand letter of credit.
If the contractor objects to the employer's call and the employer does not wish to provide a counter-guarantee, then the employer is nevertheless immediately paid under the performance guarantee, after analogous pre-arbitral proceedings, in this case obviously commenced by the employer, if and when the referee decides in the employer's favour.
Where the contractual power of the contractor is not sufficient to obtain the inclusion in the text of the contract of the above mentioned clause which in the IBA's point of view should hopefully become widespread in current commercial practice it is worthwhile remembering that also other less intrusive contractual terms addressing the same problem can be adopted, and should be taken into careful consideration in order to dissuade as much as possible the employer from calling performance bonds purely arbitrarily and in bad faith.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.