Below is a good article on performance bonds and why you need to clearly state the requirements for demand.
It’s a reminder for all of us that the language in the bond matters. You don’t want to gloss over this simple step as it can be a big reason that you choose a particular contractor or go a certain way on a project. However, messing up this detail can be costly – either by losing out on the bond or having to go through the court process.
A reminder to clearly state requirements for demand under performance bond
The recent decision of England’s Technology and Construction Court in Lukoil Mid-East Ltd v Barclays bank PLC  EWHC 166 (TCC) is a useful reminder to clearly state in a performance bond any requirements that a demand made under it must meet, in order to avoid disputes, as in this case.
The Claimant, Lukoil Mid-East Ltd (Lukoil), had engaged Baker Hughes Asia Pacific Ltd (BH) to drill and complete 23 production oil wells in Iraqi oil fields (the Contract). Pursuant to the Contract, BH delivered to Lukoil an irrevocable, unconditional, on demand, performance bond of some US$7.1 million, issued by the Defendant bank, Barclays. The bond provided that from the date of its issuance, Barclays was responsible for payment of US$7.1 million in full at Lukoil’s first written request to Barclays, made before the expiry date, if BH failed to fulfil the contractual provisions, on the condition (Condition 4) that no amendment had been made to the Contract between Lukoil and BH impacting on the timely performance of the works under it.
Letter of demand
By letter to Barclays (attaching the original bond), Lukoil requested payment of the US$7.1 million. The demand stated that BH was in breach of its contractual obligations in that it had failed to achieve any of the key milestones on or before the key dates set out in the Contract and had failed to make payment of the liquidated damages that fell due.
Bank’s refusal to pay on demand
Barclays refused to make payment, asserting that the demand was invalid because it made no mention of the condition that no amendment had been made to the Contract impacting on the timely performance of the works under it.
Lukoil issued proceedings against Barclays claiming payment under the bond.
The Court held as follows:
The terms of the bond itself will determine the formal requirements (if any) that a demand made under it must comply with in order to be valid.
The Court was required to interpret the bond as a whole. Any individual clauses or provisions that it contained, were to be interpreted in context.
The Court will not willingly endorse an interpretation that is commercially absurd, unless compelled to do so by very clear words.
There was no commercial or principled legal justification for interpreting the bond as requiring the demand to contain a statement that no amendment had been made to the Contract impacting on the timely performance of the works under the Contract, in order for the demand to be valid.
The bond, when viewed as a whole, was incoherent. Condition 5 of the bond conflicted with Condition 4, as it stated that no amendments to the Contract would relieve Barclays from their responsibilities under the bond. Barclay’s submission that it was a pre-requisite that a valid demand should include a statement that no amendment had been made to the Contract, was directly contrary to the clear intention of Condition 5, which was not merely that such amendments were irrelevant to Barclay’s obligation, but also that Lukoil was not obliged to inform Barclays of them.
It would be almost inconceivable that, in the course of a huge project like this one, there would be no changes to the scope of works that would impact on timely performance. Therefore, on Barclay’s interpretation, it was almost inconceivable that Lukoil would ever be able to make the statement required for a valid demand. The bond would therefore be rendered virtually useless on Barclay’s interpretation, which made such interpretation commercially absurd.