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Bonds & Guarantees - Maximising Your Security

Scotland
01/05/2011
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A bond is a deed by which the guarantor promises to pay another, the developer/creditor/beneficiary (the Obligee), a sum of money for stated losses (on demand bond) or damages ascertained under the terms of the underlying contract (conditional bond or parent company guarantee) in the event that the contractor (the Primary Obligor) defaults on its obligations.

Depending on the type of bond, claims can be time consuming and complex. The terminology and the procedural mechanisms in the bond should therefore confirm how and when claims can be made.

On Demand v Conditional Bonds



 The bond should be clear on the face of it as to whether it is “on demand” or “conditional”. Where the guarantor’s obligation to pay is subject only to a written demand or “call” by the Obligee, it is critical that all procedural requirements for making such claim have been satisfied. Defences to claims under on-demand bonds are limited but procedural irregularity or fraud are most common.


Is the bond conditional on proof of the default and loss incurred pursuant the underlying contract? Under a conditional bond, the guarantor is only obliged to make payment when a default occurs in the performance of the underlying contract and the claim is agreed or proven. Consequently, a dispute between the contractor and the Obligee as to the default in question may prevent a claim.

Practical Consideration

How does the Obligee make a call under the bond? The terminology must be clear in respect of procedures for making a claim (e.g. whether is on demand or conditional) and must be consistent with the underlying contract.

When does the bond expire or the bond amount reduce? This is typically at practical completion of the works in question but extra care should be taken if any other specific event has been proposed as the trigger for expiry, especially where such event is dependant on the actions of a third party.

What happens in the event of a dispute as to a default by the Primary Obligor? If such dispute is determined by an adjudicator, this decision should be expressly binding on the parties to the bond.


What events of default can trigger a claim? Is insolvency of the Primary Obligor to be an event of default? If so, it requires to be specified as such as this cannot be assumed. In such circumstances, the duration of bond should also be co-extensive with the period for determination of any account following termination upon insolvency.

How does a variation to the underlying contract affect the bond? The bond should ensure that the guarantor’s obligations are not discharged if contract is varied or amended OR the guarantor’s written consent to such variation must be obtained.

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