What intrigued me was the realisation after I had called on the bank to discharge the guarantee bonds, that unknown to me the company had resorted to self-help on default of its customers to take action by itself for the retrieval of the debt owed.
The company had confiscated the equipment of some of its defaulting customers while at the same time it had engaged the services of a lawyer to pursue the bank for the discharge of the guarantee bonds which the bank had issued on the company’s behalf to guarantee the loan in the event of default.
In my opinion, the action of the company was untenable and is totally at variance with the obligations imposed on the bank with respect to the guarantee bonds.
What is a guarantee bond?
A guarantee bond, which is sometimes called performance bond, has been spoken of succinctly by the celebrated English jurist of long standing reputation, Lord Denning, in the English case of Edward Owen Engineering Ltd vs Barclays Bank International Ltd 1978 I AER 976 CA as follows: ‘‘A performance guarantee was similar to a confirmed letter of credit. Where, therefore, a bank had given a performance guarantee, it was required to honour the guarantee according to its terms and was not concerned whether either party to the contract which underlay the guarantee was in default. The only exception to that rule was where fraud by one of the parties to the underlying contract had been established and the bank has had notice of the fraud.’’
The rationale for guarantee bonds
It is often the case that suppliers and contractors are often called upon to provide guarantee bonds. Guarantee bonds often operate in two ways. For example, a supplier who has been contracted to supply goods can demand a guarantee bond simply as a guarantee that the goods when supplied will be paid for. Also, a government which awards a contract especially to a foreign contractor may be required to furnish a guarantee bond which guarantees payment by the government.
This is because the foreign contractor might not have any physical presence in the country and will only set up in a country purposely for executing the contract. If it does not get paid after executing the contract, it might find it laborious and time consuming to litigate with the government or the entity which awarded it the contract before it gets paid. Another difficulty that such a foreign contractor might encounter would be that even if it wins the case, it might not be able to carry into effect the judgement due to the difficulty of execution. The other difficulty would also be that a country or government which contracts a foreign company to execute a project for it might not have a strong judiciary before which an action can be brought to enforce payment in case of default. Other forms of guarantee bonds or performance bonds are bid bonds which require a supplier or contractor to furnish a bid bond. This will give the assurance to the entity awarding the contract that it is only dealing with serious entities which have the requisite capacity to execute the work.
Brief facts of Edward Owen Engineering v Barclays Bank International
In 1976, Edward Owen Engineering Limited, a United Kingdom (UK)-based firm, was contracted to supply and install glass houses in Benghazi by a Libyan company.
Edward Owen Engineering Limited demanded that the Libyan company should furnish a guarantee bond to assure it of payment. This was done by the Libyan company through its bank, the Umma Bank in Libya. Umma Bank further advised its correspondent bank, Barclays Bank in London, of the guarantee which meant that Barclays Bank would discharge the guarantee in favour of the Libyan company upon demand.
The Libyan company was to issue an irrevocable letter of credit which it did not issue eventually and which did not comply with the contract between Edward Owen Engineering Limited and the Libyan company.
The Libyan company defaulted on its agreement with Edward Owen Engineering Limited and yet demanded the discharge of the guarantee bond which was accordingly discharged by Barclays Bank.
In an action by Edward Owen Engineering Limited to countermand the guarantee to Umma Bank for the benefit of the Libyan company due to the non-fulfilment of the underlying contract, it was ruled by the English court that Barclays Bank was justified in discharging the guarantee in favour of the Libyan company. The court in its judgement stated the ‘‘locus classicus dictum’’ on guarantee bonds which had earlier been stated.
The law relating to guarantee or performance bonds
In stating the law on guarantee or performance bonds, Lord Denning, with whom lawyers and jurists have compared to the late Justice J.N.K. Taylor JSC, acknowledged the subject of performance bonds as being a ‘‘new creature’’ at the time. Nevertheless, he drew similarities with letters of credit in the earlier case of Hamzah Malas and Sons vs British Imex Industries Limited 1958 I AER 262 @ 263 which stated as follows:
‘‘It seems to be plain that the opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes on the banker an absolute obligation to pay irrespective of any dispute which there may be between the parties on the question whether the goods are up to contract or not. An elaborate commercial system has been built up on the footing that bankers’ confirmed credits are of that character and in my judgement, it would be wrong for this court in the present case to interfere with that established practice.’’