THE LEGAL POSITION OF BANKS IN PERFORMANCE BOND CASES
LL.B., Ph.D., Lecturer in Law, University of Liverpool .
Under an international contract of sale the need for the buyer to insure against the failure of the seller to fulfil his obligations to deliver the goods and for the seller to insure against the failure of the buyer to pay the purchase price has resulted in the development of performance bonds, otherwise known as performance guarantees. If, therefore, the buyer is uncertain whether the seller will be able to supply the goods, or to complete the contract in the case of a construction undertaking, he will ask the seller or supplier to procure such a guarantee from a third person, usually a bank. Similarly, the seller or supplier may ask the buyer for a performance guarantee if he is uncertain whether the buyer will be able to pay the contract price of the goods. If a performance guarantee cannot be arranged, the seller can ensure that he will receive payment by stipulating that payment under the contract will be by a commercial documentary credit. A performance guarantee is therefore more significant to a buyer when he wants an indemnity against the possible failure by the seller to perform the contractual undertaking because the seller can ensure he receives payment by a letter of credit when a performance guarantee is unavailable.
It is proposed in this article to examine the legal effect of performance guarantees and the position of the bank giving the guarantee in law. A performance guarantee, or bond, unlike a letter of credit, is issued at the request of the buyer under the international contract and the bank guarantees to the buyer that if the supplier or seller fails to perform his contractual undertaking, the buyer has a right to call on the bank to pay the amount of the guarantee. A performance bond is therefore an unconditional undertaking entered into by the bank, at the request of the buyer, giving a guarantee to him that if the seller, for any reason, fails to complete his obligations under the contract, the bank will pay, on demand by the buyer, the agreed amount of the bond. A bank is under no obligations to notify the seller that a demand has been made under the performance guarantee.
A bank can be called upon to honour the guarantee it has given to the buyer if the seller fails to comply exactly with the terms of the obligations under the contract. As in the case of letters of credit, substantial fulfilment of the contractual obligations is insufficient. Compliance with the undertaking must be exact and the supplier is not allowed to rely on the de minimis rule. 1
1 Bank Melli Iran v. Barclays Bank D.C.O .  2 Lloyd’s Rep. 367.
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