Performance Guarantee and Its Relevance in Infrastructure Projects

CONTRIBUTED BY EFERAOMON ISEGHOHIME

INTRODUCTION

Public-private partnerships (PPPs) have been put through a stress test as a result of the COVID-19 pandemic, and risks that seemed appropriate for the private sector to assume a few months ago may no longer be acceptable today. PPP ventures have now begun to redefine bankability and try to shift additional risks to the government as a result of supply chain problems and decreased demand. This has led to a rise in demand for government assurances. Considering Infrastructure Projects are mostly capital-intensive and skill-intensive projects, the place of Performance Guarantees in Infrastructure Project Contracts cannot be over-emphasized.

WHAT IS A PERFORMANCE GUARANTEE

A performance guarantee is a legal promise made by one party to another, and typically backed by a third-party financial institution, to ensure the fulfilment of contractual obligations. Its main purpose is to safeguard a beneficiary, against the non-performance, delayed or inadequate performance by a contractor, and allow quick access to funds in custody of the third-party financial institution to remedy the breach.

This is however different from Performance Bond. The term Performance Bond is often misleading, which can leave Parties confused about the difference between a performance bond and a performance guarantee. Most construction Performance Bonds are actually Guarantees. Bonds and Guarantees are related but are different. The right to claim under a Guarantee is linked to the non-performance of the underlying contract. Under a Bond, the third-party financial institution usually pays on demand regardless of the underlying contract[1].

One question has however been very prominent in the discussions of Performance Guarantees. At what point does the bank or third-party financial institution’s liability in the contract crystalize?

The bank’s undertaking is a primary liability that crystallizes upon the beneficiary’s compliant demand, without any reference to the question of the principal’s default in the underlying contract. This principle was recognized in the recent case of Nwosu v. Zenith Bank Plc[2] thus:

“A banker’s guarantee shall effect payment on demand by the beneficiary giving a written statement that the principal has failed to perform his obligations. Such written statement will be the sole condition for the guarantor to pay under the guarantee. The guarantor will not take additional steps to determine any facts or documents relating to the underlying contract or the very appropriateness of the claim.”

This is a great advantage to whichever party in the contract would be most exposed and affected by a breach in the contract. It further gives immediate access to cash to remedy any contractual default, without having to await a protracted judicial determination of the allegation that the other party has committed a breach of contract and, if so, the extent of his liability in damages.

TYPES OF PERFORMANCE GUARANTEE

  1. CONDITIONAL GUARANTEE: The enforcement of this kind of guarantee depends upon some extraneous event, beyond the mere default of one party and generally upon notice of the default, and reasonable diligence in exhausting proper remedies against the defaulting party.
  2. ABSOLUTE GUARANTEE: This is an unconditional undertaking by the third-party financial institution that the party in debt will pay the debt or perform the obligation. It is an unconditional promise of payment or performance of the principal contract on default of the obligor.
  3. COLLATERAL GUARANTEE: This is a contract by which the third-party financial institution undertakes in case the party to fulfil the obligation fails to do what he has promised or undertaken to do, such as pay damages; as distinguished from an engagement of suretyship in this respect that a surety undertakes to do the very thing which the principal has promised to do, in case that latter defaults.
  4. CONTINUING GUARANTEE: A continuing guarantee is a guarantee in which a third-party financial institution agrees to be held responsible for a series of transactions for the financial obligations and the performance of contractual obligations by the obligating party to the other party, in the event the obligating party fails to discharge his financial obligations or perform the contractual obligations. In the case of a continuing guarantee, so long as the account is a live account i.e. the account is un-settled and there is no refusal on the part of the third-party financial institution to carry out the obligation, the period of limitation does not at all start to run.
  5. SPECIAL GUARANTEE: This guarantee is available only to a particular person to whom it is offered or addressed, as distinguished from a general guarantee, which will operate in favour of any person who may accept it.

For a performance guarantee to be valid, there are basic elements that must come to play as emphasized in Umegu v. Oko[3] and these are:

  1. There must be three parties in the contract, namely:
  2. A Creditor.
  3. A Principal debtor.
  4. A promisor who undertakes to discharge the principal debtor’s liability should the latter fail to discharge it himself i.e. more often than not, the financial institution.
  5. There must be an agreement between the parties;
  6. The agreement must be in writing and if not under seal, there must be valuable consideration; and
  7. The contract or agreement must not be illegal as illegality generally renders any contract null and void ab initio and the party seeking to enforce it will have no remedy in a court of law.

The Court held in Salawal Motor House Ltd v. Lawal[4], that it is the law that a guarantor of a loan is technically a debtor because where the principal debtor fails to repay, the guarantor will be called upon to pay the loan so guaranteed. Immediately a guarantor signs the guarantee form, he automatically makes himself liable for the default of the debtor in case of default. This is the extent, to which the law protects the creditor to a performance guarantee in a contract.

CONCLUSION

Nonetheless, the motive for imputing the performance guarantee in a contract by parties, whether in a separate contract covering another contract or a single tripartite agreement containing the clause. It constitutes a very useful weapon in the hands of the creditor because it affords him options such as the right to pick or choose whom to sue (Depending on the financial prowess of his options).

In addition, there can be more than one guarantor under a single contract and the creditor can proceed against any or all of them to recover the debt where the original debtor defaults or absconds.

However the guarantor(s) after bearing liability for the debt can proceed against the original debtor to recover the sum (including the cost of defending the action against him by the creditor if the matter went to court), but in most cases, the need for a guarantee would arise where the original debtor’s financial state is not trusted as being able to solely repay the debt thus the need for an extra hand in the form of guarantors.

This, therefore, begs the question, if the debtor is unable to pay the creditor how would the guarantor be expected to get his money back? Certainly, the guarantor(s) would be faced with a serious problem retrieving his money back from an individual who is probably bankrupt or even worse who has absconded.

This is why third-party financial institutions, request security deposits from the principal debtor before acting as guarantors in any contract.

Hence, the importance of performance guarantees cannot be overemphasized in contracts relating to infrastructure projects in this present-day economy.

  1. Dan Payton, ‘What’s the difference between a Performance Bond and a Performance Guarantee?’ (2018) <https://civilsure.co.za/difference-between-a-performance-bond-and-a-performance-guarantee/>
  2. [2015] 9 NWLR (Pt. 1464) 314, 323 [B].AA
  3. (2001) 17 NWLR (Pt. 741) Pg. 156. Paras. A-D
  4. (2000) FWLR (Pt 3) 577

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