Lloyd's Maritime and Commercial Law Quarterly
PERFORMANCE GUARANTEES
By Martin Coleman *
The prevailing wisdom concerning performance guarantees is that they are analogous to letters of credit and that the fundamental rule of the separation of the letter of credit contract from the underlying contract applies to performance guarantees. In the absence of fraud, a bank is required to pay a beneficiary when a demand under a performance guarantee is made in the form specified in the guarantee even if the demand is made in breach of the underlying contract between the beneficiary and the party on whose instruction the guarantee was opened (the account party).1 Few judges have gone so far, however, as to say that performance guarantees operate in precisely the same way as letters of credit, and in a recent case Eveleigh, L.J., cast doubt on whether it was appropriate to treat performance guarantees as a species of letters of credit.2
Terminological confusion flourishes in this field. The following terms have at different times been used to describe what is essentially the same instrument while on other occasions the terms have been used to refer to a variety of different instruments: performance guarantee; performance bond; first demand guarantee; standby letter of credit.
The most common arrangement involves three or more parties. An account party instructs a bank or other financial institution to provide a guarantee in favour of a beneficiary. The bank may instruct a second bank to provide the guarantee and the second bank may similarly instruct a third. The guarantee will usually be in respect of an obligation owed by the account party to the beneficiary under a contract (the underlying contract) and the requirement to provide the guarantee will usually be a term of the underlying contract. The bank will require the account party to provide an indemnity in the event of the bank paying out on a claim under the guarantee, and the indemnity obligation may be accompanied by a sophisticated loan agree-
* Solicitor, Norton Rose, London.
1. Performance guarantees have been considered in the following cases: Elian & Rabbath v. Matsas & Matsas
[1966] 2 Lloyd’s Rep. 495; R. D. Harbottle (Mercantile) Ltd. v. National Westminster Bank Ltd. [1978] Q.B. 146 (hereafter “Harbottle”); Edward Owen Engineering Ltd. v. Barclays Bank International Ltd. [1978] Q.B. 159 (hereafter “Edward Owen”); Howe Richardson Scale Co. Ltd. v. Polymex-Cekop
[1978] 1 Lloyd’s Rep. 161 (hereafter “Howe Richardson”); Bolivinter Oil S.A. v. Chase Manhattan Bank N.A. [1984] 1 Lloyd’s Rep. 251 (hereafter “Bolivinter”); Potton Homes Ltd. v. Coleman Contractors Ltd. (1984) 28 B.L.R. 19 (hereafter “Potton Homes”); GKN Contractors Ltd. v. Lloyds Bank Plc (1985) 30 B.L.R. 48 (hereafter “GKN v. Lloyds”); Esal (Commodities) Ltd. v. Oriental Credit Ltd. [1985] 2 Lloyd’s Rep. 546; United Trading Corp. S.A. v. Allied Arab Bank Ltd. [1985] 2 Lloyd’s Rep. 554 (hereafter “UTC”); Egyptian International Foreign Trade Co. v. Soplex Wholesale Supplies Ltd. [1985] 2 Lloyd’s Rep. 36; Siporex Trade S.A. v. Banque Indosuez
[1986] 2 Lloyd’s Rep. 146 (hereafter “Siporex”); Hong Kong and Shanghai Banking Corp. v. Kloeckner & Co. A.G. [1989] 2 Lloyd’s Rep. 323; I.E. Contractors Ltd. v. Lloyds Bank Plc
[1989] 2 Lloyd’s Rep. 205.
2. Potton Homes, at p. 29.
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