Bank guarantee in a construction contract

Bank guarantee in a construction contract. The problem of preventive demand for payment of the guarantee.

Preventive request for payment of bank guarantee

One of the problems faced in the practice of realization and payment of construction contracts is the situation of the Investor’s preemptive demand for payment of a bank guarantee for a future, unspecified and unmatured receivables. The Investor often obtains a preemptive demand payment from the Guarantor due to the unconditional and abstract (in the Beneficiary-Guarantor relationship) nature of the collateral.

However, in the relationship between the Investor and the Contractor, such a preventive demand is a violation of the law (including Article 471, 405, 415 of the Civil Code) and is contrary to the function of the bank guarantee. In fact, before demanding payment of the guarantee, the Investor should notify the Contractor of a specified demand and set a deadline for payment (allow the Contractor to make the payment).

In general terms, the mechanism of a bank guarantee implies:

1. the establishment of the Investor’s claim
2. a request for payment to the Contractor with an indication of the basis, amount and date of payment
3. a lapse in the payment term to no avail
4. a request for payment of the bank guarantee.

This means that the bank guarantee can be executed only as the final stage of the Investor’s claim. In particular, it is necessary for the Investor to identify a specific claim (defined as to basis and amount). Such conclusions also derive from Article 449 § 2 of the public procurement law (“the collateral serves to cover claims”), and are also confirmed in the practice of construction contracts. Indeed, clauses are often included in contracts, according to which the guarantee provided “secures claims” or is provided “to cover claims”. The same position is presented by the courts (e.g., Judgment of the Court of Arbitration in Katowice of 25.06.2014, I ACa 261/14).

It should be emphasized that the Investor cannot use the granted security against future and hypothetical receivables. This is because the claim does not exist yet. Consequently, a bank guarantee cannot cover such non-existent claims.

To give an example: the Investor cannot demand payment of the security and only subsequently provide the Contractor with justification by later creating contractual penalties for defects in the completed work.

Contractual loyalty. Increased cost of financial instruments.

Demanding payment of the guarantee without giving the Contractor an opportunity to pay the claim is also a breach of the principles of contractual loyalty and the duty of the parties to cooperate in the fulfillment of the contract. First of all, the Investor should allow the Contractor to address the substantive basis of the claim. The Contractor should also have the opportunity to voluntarily pay the claim. The guarantee mechanism itself should be used as a last resort (ultima ratio), in the event of a dispute – not as a primary premise.

In addition, surprising the Contractor, who only learns about the implementation of the security from the Guarantor, undoubtedly does not meet good standards of commercial fairness.

Significantly, a premature and unauthorized demand for payment entails unreasonable costs for the Contractor. In addition to the obvious claim of the Guarantor for the return of the paid guarantee, the Contractor will incur increased costs related to the use of financial instruments in the future. As a result of the execution of the collateral issued on behalf of the Contractor, the assessment of the Contractor’s credibility carried out by financial institutions decreases. Consequently, the Contractor must expect increased costs of using financial instruments in the future. By definition, the above correlation further motivates the Contractor to properly perform the contract, which is one of the functions of a bank guarantee.

All the presented arguments show that the Investor is not entitled to preemptively demand payment of the bank guarantee. Such a demand may be the basis of the Investor’s liability towards the Contractor.