This article has been written by Mansi Gehrana, pursuing a Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. It has been edited by Smriti Katiyar (Associate, LawSikho).
A performance guarantee protects the interests of the employer. Some of the essential clauses in a performance guarantee contract are concerned with the guarantee amount, obligation of the guarantor, dispute resolution & governing laws, etc. These clauses are not exhaustive but only illustrative to provide a roadmap to achieve as envisaged by the parties to a performance guarantee contract.
The guarantee is for performing the obligations of the contractor/supplier as stipulated in the contract by the client/beneficiary. While entering into a contract, the client asks explicitly for the bank guarantee and the bank gives an undertaking on behalf of the contractor to re-pay the client in case of default or in case of breach of the terms and conditions of the contract or the non-performance of the contractor’s obligations.
These are the conditions precedent used by the client for entering into the contract. In the case of Edward Owen Engineering Ltd. v Barclay’s Bank International Ltd., the performance bond or the letter of credit stands on a similar footing. A bank that gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with supplier and customer relations nor whether the supplier has performed his obligations. The bank must pay according to its guarantees, on-demand if so stipulated, without proof or conditions.
Parties to performance guarantee
There are three parties to a performance guarantee:
The first party to the contract is the contractor/supplier who is obliged to perform his (duties) obligations according to the terms and conditions of the agreement.
The client is the other party to the contract for whom the obligation is being performed. Upon completion of which he is required to pay the stipulated amount as in the contract.
In a performance guarantee, the guarantor is the bank. The bank undertakes the payment to the client on behalf of the contractor/supplier in case of breach of the terms and conditions of the contract.
Types of performance guarantee
There are basically two commonly used types of performance guarantee:
Advance payment guarantee
There is a very prevalent practice of taking credits before the delivery of goods or performance of the contract’s obligations, the bank backs the payment of money. It assures in case of violation of any terms and conditions of the contract to repay back the sum by the contractor.
This guarantee applies to both domestic as well as international tender. When the contractor is obliged to perform his part of the obligations of the contract; it is also known as the “Bid Bond” guarantee.
Essential clauses in a performance guarantee agreement
Unconditional and irrevocable liability
A bank guarantee is an independent contract between the bank and the client/ beneficiary irrespective of any contract between the contractor and the client. In the case of Ansal Engineering Projects Ltd. v Tehri Hydro Development Corporation Ltd. and another, In a bank guarantee, the bank unconditionally and irrevocably promised to pay, on-demand, the amount of liability undertaken without any demur or dispute.
Obligation of the guarantor
The guarantor is liable unconditionally and irrevocably for any breach of terms and conditions of the contractor/supplier. In State of Maharashtra v Dr M.N Kaul and another, it was held that a guarantor could not be held liable beyond the terms of his agreement.
Specified amount and period
The amount for which the bank undertakes to pay should be specified in clear and concise terms, it should not be vague. And the period for which the bank is liable on behalf of the contractor/seller should be specified, though the guarantee is always continuing. Still, it can never be for an unlimited duration.
For giving the legal recognition to the bank guarantee and to enforce it by the client at any time without being questioned, it is necessary to get the bond made on a non-judicial stamp paper of INR 100 or the according to the laws of State whichever is higher.
Dispute resolution and governing law
In case of any dispute between the parties, an arbitration clause should be provided in the bond. The panel of arbitrators, venue, and seat of the arbitration, and the costs of arbitration have to be there and the governing laws i.e., the Indian laws would be applicable in case of any disputes between the parties. It is equally settled in law that in terms of the bank guarantee the beneficiary is entitled to invoke the bank guarantee and seek encashment of the amount specified in the bank guarantee. It does not depend upon the result of the decision in the dispute between the parties, in case of the breach. The underlying object is that an irrevocable commitment either in the form of a bank guarantee, or letters of credit solemnly given by the bank must be honoured.
An attestation of the bond by at least two witnesses is necessary for authentication of the bond.
The performance guarantee bond is signed to secure the credit of the client. The bank undertakes to pay for the breach of the contractor’s obligations to keep everything under the sun. By signing, the performance guarantee bond client can easily enforce the terms against the contractor/supplier and the bank in case of any disputes. It will help in checking the activities performed by the contractor/supplier and the performance of the same. It will parallelly secure the interest of the client.
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