Bonds in Construction Contracts

April 02,2023

Written by: Ali Al Rashdi, Kerem Alev

Many types of bonds are used in Construction projects such as Tender Bonds (sometimes called Bid Bonds), Advance Payment Bonds and Performance Bonds. In this Article, we look at Performance Bonds.

Many standard form construction contracts require the Contractor to submit a Performance Bond to the Employer (e.g. Oman’s Standard Contract for Building and Civil Engineering Works or the FIDIC suite of contracts).

What is a Performance Bond

This is a type of demand guarantee issued by a Bank to the Employer at a Contractor’s request. The guarantee secures the performance of the Contractor’s obligations under the construction contract.

The bond amount will usually be a percentage of the price of the value of the contract and the terms of the bond will be such that it will be payable on demand. The Contractor’s ability to challenge the demand will often be limited.

Further, the Employer can call on the demand without having to demonstrate that it has suffered any loss from the Contractor’s default when it calls on the bond.

This form of security is widely requested by many if not all, Employers. In particular,  Contractors to Government led projects in Oman will usually need to submit a Performance Bond shortly after being notified of the Government’s award. This requirement is usually non-negotiable.

In the Oman Standard Contract, the Performance Bond takes the form of a letter addressed to the Employer by the proposed bank confirming the bank’s irrevocable and unconditional agreement to pay the bond amount upon receipt of a written demand.

Articles 393 to 397 of the Commercial Law No. 55 of 1990 deal with such letters and it is stipulated there that where a bank has, at the request of its customer, issued a letter guaranteeing payment of money to a third party beneficiary on unconditional terms, then the bank has no choice but to comply with the beneficiary’s call on the guarantee.

As such, one can see that Performance Bonds can provide an Employer with a fast and efficient remedy in the event of the Contractor’s default.

Therefore, Performance Bonds can leave the Contractor in a vulnerable position, and it raises the question of what remedies a Contractor might have, if any if it believes it has not defaulted in its performance of the contract?

Can the Contractor do anything to stop the Bank from paying the bond?

As stated above, Article 393 to 397 of the Commercial Law No. 55 of 1990 stipulate that the bank has no choice but to comply with the demand.

However, a Contractor may have a right to seek an interim order preventing payment as the Commercial Law does not expressly rule out a Court from ordering the Bank to not pay out the bond.

That said, the Oman Supreme Court previously decided on this issue on an appeal from the Court of Appeal. In its judgment, it overturned the Court of Appeal’s decision stopping the payment of a performance bond pending the outcome of an ICC Arbitration between the Contractor and Employer.

The Supreme Court said that preventing the payment of the bond was wrong as it undermined the purpose of letters of guarantees and that the Court of Appeal’s decision weakened confidence and the reliance placed on them by Employers.

The Supreme Court’s decision does assist with this question, however, it should be noted that the Oman courts do not follow the doctrine of stare decisis in the traditional common law sense, therefore, decisions of the Supreme Court are not binding on other Courts. That said, the Oman Courts do however give priority to consistency and the stability of the judicial process therefore the judgment is still important.

What can the Contractor do after the Bank has paid the Employer?

The Contractor may initiate legal proceedings against the Employer seeking the payment of the full amount of the bond. Such proceedings will either usually be by way of Court or Arbitration as most standard form construction contracts provide the parties to choose between the two at the outset when the contract is first agreed.

To succeed, the Contractor will need to prove that he was not in default of his contract performance.

S & A Law Firm