Bond Guide

The BExA Guide to On-Demand Contract Bonds
We are pleased to present our updated BExA Guide to On-Demand Contract Bonds. Our rst Bond Guide was published in October 2004 and much has changed since then. New ICC Rules for Bonds (URDG 758) have replaced URDG458. Similar updates have been made to rules on letters of credit and delivery terms. Another milestone has been the introduction, after much pressure from BExA, of UK Government support for the issue of bonds: the Bond Support facility from UK Export Finance. And then there has been the change in the banking environment: the nancial crisis that started to bite in 2008, and which continues to inuence bank strategies and regulation (Basel III being the most notable), changed banking perspectives irrevocably. This 2013 edition of the Bond Guide has been more than updated: it has been re-written. At BExA, we see real value in sharing experiences to help fellow exporters to fathom and manage the complexities of risk and nance in trade. We are delighted that our vision is shared by our sponsors who have nanced the publication of this Guide and therefore deserve our thanks. Please do review their literature in the nal pages of thisGuide. Jon Coleman Chairman, the British Exporters Association September 2013
CONTENTS FOREWORD EDITORS NOTE Chapter 1 WHAT IS AN ON-DEMAND CONTRACTBOND? On-demand, unconditional or conditional, bond types, SBLCs, extend or pay, other forms of guarantee, bond issuers THE CUSTOMERS VIEW THE BANKS VIEW Exporter risk, security, pricing, banks, bond wording, destination, UK Export Finance bond support, capital allocation, fees, practicalities, MAC clause, largebonds. THE EXPORTERS VIEW Credit risk, putting the bond in place, cost, risk of call, joint ventures, bond watchlist. THE LAWYERS VIEW WHAT TO WATCH OUT FOR AND WHAT TO AVOID Watch list, what toavoid. EXTEND OR PAY YOUR BOND IS CALLED UNFAIR CALLING INSURANCE Insurance, exclusions, how the cover works, tender bond cover URDG SOME SAMPLE WORDINGS LOCAL LAWS AND CUSTOMS THE UN CONVENTION TERMINOLOGY 2 3 5
Chapter 2 Chapter 3
12 14
Chapter 4
23
Chapter 5 Chapter 6
29 32
Chapter 7 Chapter 8 Chapter 9
39 42 44
Chapter 10 Appendix 1 Appendix 2 Appendix 3 Appendix 4
49 50 53 59 61 63
SPONSORS LITERATURE
FOREWORD What are contract bonds? The answer is that they are a nancial guarantee of your performance. However, being unconditional, the exporter, in providing the guarantee, is, in a sense, saying to his customer: Here you are, help yourself to my money whenever you like. There may be very good reasons (ifyou are the customer in such a transaction) for requiring such an arrangement but the fact of the matter is that bonds present all sorts of difculties for the exporter and the banker. It is the purpose of this guide to help exporters navigate this interesting subject and come out the other side, moneyintact. Surprisingly for nancial instruments that are independent of the contracts that they guarantee, and allow drawdown of sizeable amounts of cash, most bonds are individually written. There is an international set of rules for bonds and guarantees (the ICCs URDG) but many bonds are not subject to itsdisciplines. Finance has tightened in recent years. The economic environment, together with increased regulation has led to banks restricting overall lending, including bonding lines. BExA lobbied energetically for many years for British exporters to have access to Government support for the raising of bonds. We are pleased, therefore, that in 2011, Bond Support was made available from the Governments UK Export Finance (the trading name for ECGD). Bond Support enables the bank to issue bonds morereadily. The intention of this guide is to share practical experiences relating to bonds such that British exporters gain condence in the subject and do not shy away from bidding for contracts because of the necessity to provide ondemandbonds. This is not the only BExA guide. The stable of BExA guides now totals seven1, all of which are based on exporters hard experience and are written by exporters for exporters with invaluable contributions from BExAs banking and insurancemembers. Rt Hon Earl of Kilmorey PC President, the British Exporters Association Minister of State for Trade 1992 - 1995 September 2013
BExA Guides to Successful Exporting, Financing Exports, Letters of Credit, Export Credit Insurance, Retention of Title, Export Compliance and OnDemand Contract Bonds can be downloaded from www.bexa.co.uk. Printed copies are provided to BExAmembers.
Foreword
EDITORS NOTE On-demand contract bonds The term bond is widely used in nance and trade. In the days of open trading, the London Stock Exchange had the phrase my word is my bond inscribed on its coat of arms to conrm that a verbal agreement was an effective contract. This notion of guarantee has been used to describe a range of instruments, not only contract bonds which are the subject of this guide, but also nancial bonds (also known as corporate bonds) which are a means of raising money in the capital markets and which guarantee a regular interest payment as well as the return of your money after an agreedperiod. In this guide, we focus on on-demand contract bonds that support export contracts. Sometimes called independent guarantees, these bonds are provided on behalf of an exporter for the benet of its customer. They can be called without the agreement of the exporter or even the assessment of an independent third party. We will consider other export-related bonds only briey, principally in illustrating points of particular interest or importance with regard to on-demand contractbonds. The purpose of the bond is to provide the customer with a degree of security, perhaps in respect of costs he may have incurred or payments that he may have made in advance to the exporter, or for the proper performance of the contract (or of the goods and services supplied under the contract) by the exporter. It provides a ready redress for the exporters failure to perform itsobligations. Terminology In preparing this guide we have tried to maintain a degree of consistency with regard toterminology. The exporter: this guide is written from the point of view of a company exporting goods or services from the UK to a countryoverseas. Where it appears, you means theexporter. The customer is the exporters counter-party, the purchaser of the goods orservices. The beneciary is the person to whom the bond is given (usually the customer in the exportcontract). For the purposes of this guide the words bond and guarantee are synonymous, being the instrument by which a bank undertakes to make a payment to a beneciary in circumstances specied in it, for example the unsatisfactory performance of theexporter. The issuing bank is the bank which issues the bond at the request of the exporter. It may be the exporters bank but is more likely to be an overseas bank, local to thecustomer.
Editor's Note
Other reference material The International Chamber of Commerce (ICC) produces a number of documents that are directly relevant to contract bonds, and which should therefore be part of the exporters library,especially: Uniform Rules for Demand Guarantees - ICC 758 - see Chapter10. Incoterms 2010 (ICC terms of delivery) define when delivery takes place plus which party is liable for transport andinsurance. Standby letters of credit, which have much in common with bonds and guarantees, may be subject to International Standby Practices (ISP98) or occasionallyUCP600. Contributors The 2004 BExA bond guide was compiled and edited by Richard Hill of BAE Systems along with exporters and their advisers andbankers: Robin Arthur of ANZ Malcolm Booth of BExA Tony Chitty of Mace David Donnelly of Alstom Richard Heyhoe of ANZ John Lodge of Marconi Selenia Communications Michael Possener, Export Consultant Susan Ross of Aon Jeremy Smith of LloydsTSB John Tyler of Alstom
This 2013 update of the Guide has been compiled with the helpof: Andrew Bennion of AIS David Benton of Rolls-Royce Jackie Lea of Rolls-Royce Deborah Bass of Credit Agricole Mark Bull of Alstom Jon Coleman of BAE Systems Allan Dowie David Ellis of Converteam Tony George of Ince & Co Ed Harkins of Barclays Lorna Johnston of Aon Glyn Powell of Trade Finance Partners Chris Siegl of Sovereign Star Guillaume Simonnet of Thales Patricia Smith of Alderley John Tyler Andy Wheatley of CA-CIB
Any value which it might have is attributable to them and to their contributions. All views expressed arepersonal. Susan Ross Aon Trade Credit Vice President, the British Exporters Association www.bexa.co.uk September 2013 Copyright & disclaimer All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by other means, electronic, mechanical, photocopying or otherwise without the prior permission of the British ExportersAssociation. Whilst every reasonable effort has been made to ensure accuracy, information contained in this publication may not be comprehensive and readers should not act upon it without seeking professional advice from their usual professionaladvisers.
Editor's Note
CHAPTER 1 WHAT IS AN ON DEMAND CONTRACT BOND? The history of on-demand contract bonds can be traced back to the oil boom of the 1970s when Middle East countries, ush with money, wanted their own airport, aluminium plant, hospital etc. Numerous contracts were put out to tender and awarded to all sorts of companies, some of whom then were unable even to start the contract, let alone nish it. Having had their ngers burnt and money wasted these countries started to require easily redeemable bonds as a condition of every contract. Some countries even passed laws making bonds mandatory in all public sectorcontracts. On-demand An on-demand contract bond is a payment undertaking, issued by a bank to the customer (the beneciary) at the request of the exporter. It is a primary undertaking of the issuing bank, and is independent of the exporters contractual delivery/performance obligations. The bond is on-demand because the issuing bank undertakes to pay the beneciary upon receiving a simple demand - a call - for payment. Some on-demand bond wordings simply require the beneciary to make a written demand for payment without having to give any reason for the demand (these are common in the Middle East), whilst others require the beneciary to state that the exporter is in default of his contractual obligations and, possibly, to describe the nature of thatdefault. Unconditional or conditional On-demand bonds are unconditional to the extent that, for the bank to pay, the beneciary simply has to satisfy some basic conditions (e.g. relating to the validity of the bond itself and the stated procedure for making the call), without having to provide evidence to demonstrate that the exporter has not performed its contract, or even to present the original bond. The exporter cannot stop the customer getting the money if the bond iscalled. As soon as the bank pays the beneciary, it will immediately take recourse against the exporter under the counter-indemnity, usually by debiting the exporters bank account. This means that in effect the bank is paying out the exportersmoney. It is sometimes possible to negotiate conditional bonds (typically issued by insurance companies and called surety bonds). With these, the beneciary has to provide evidence to the issuer - e.g. of the exporters failure to deliver goods in accordance with the timescale envisaged in the contract, or the exporters written admission of fault, or a court order or arbitration award in favour of the beneciary - as part of the process of calling the bond. This need to produce supporting documentation makes the bond conditional. You can add words creating conditionality in a bond issued by a bank. Notwithstanding the added security of conditionality, lawyers recommend that the bond is kept as simple as possible lest the additional clauses create conicts elsewhere in the contract. The issuing bank, also, will be keen to have absolute clarity on whether a bond call isvalid. Some on-demand bonds are not issued to the customer, but to another party in connection with the export contract; the most common being to a customs authority for the purpose of deferring duty on goods imported temporarily into a country pending their re-export. The importing countrys customs authority requires a bond covering the value of the duty that will need to be paid if the goods are not re-exported within a certain timeperiod. Chapter 1: What is an on demand contract bond? 5
Types of bond A bid (or tender) bond may be required when a customer issues an open request for tenders for the supply of equipment or the performance of services. It should be remembered that the establishment of a complex competitive international tender process represents a signicant investment on the part of the customer. In anticipation of receiving a number of responses and not wanting to waste time choosing a winning bidder only to have the lucky exporter refuse to take the contract, the customer will ask bidders to provide a bid bond for a small percentage (perhaps as much as 3%) of the bid price to demonstrate real commitment on the part of each bidder. This bond could be called in the event that the contract was awarded but the bidder chose not to accept it. The bid bond also evidences to the customer that the supplier making the bid has the nancial resources to perform the contract, on the basis that the bank would not issue the bond unless the bank believes the supplier is creditworthy. There is a growing tendency for customers to specify that the bond could also be called if the successful exporter was awarded the contract but failed to provide an advance payment bond or a performance bond. Therefore, before providing a bid bond, it is important to ensure that you will be able to raise any required contract bonds in a form acceptable to thecustomer. Whilst the request for tenders might specify, say, 1% of bid price as the value of the bid bond, it is wise not to raise the bond for exactly that value but to round up the value of the bond. Consider a competitive bidding situation. You are keen to win the contract and bid at your lowest possible price; this is likely to be a precise, not a round, number. If your bid is priced at, say, 10,256,786.33 your 1% bid bond would be for 102,567.86. Now, if one of your competitors should discover the value of your bid bond, it is not difcult to calculate the probable price of your bid. You might nd that the competitor then bids at 10,255,000 to win the contract on price. It is much better to round up the value of your bid bond in order to avoid this risk. A bond with a value of 105,000.00 for example, would not give too much away about your bid price and it might be worth the extra cost to increase the value of your bond in thisway. An advance payment guarantee (APG), which tends to be called a guarantee rather than a bond, is a bond given to the customer in exchange for an advance or mobilisation payment. If the contract calls for a down-payment of 25% of the contact price to be made within 30 days of signature of the contract then it will probably also require you to procure the issue of an APG for the same value in return. If your contract contains an effectiveness clause (such that a number of conditions have to be met before the signed contract comes into force) then the advance payment and receipt of the APG will probably feature in the list of conditions which have to befullled. The APG should guarantee the return of the advance payment in the event that you are unable to perform the contract. Be careful that this is all done in the right order: some customers will demand the APG before handing over any money, and/or will suggest the receipt of the APG is a condition precedent to effectiveness of the contract. You do not want to be in the position of having handed over the APG without having received any payment yet being obliged to start the contract (this hashappened!). A partial safeguard in this situation is to condition the bond so that it does not become effective and cannot be drawn upon until the advance payment has been received. However, the issuing bank is unlikely to know if theadvance 6 Chapter 1: What is an on demand contract bond?
payment has been received, so it is better either a) to arrange for a simultaneous exchange of money and bond, or b) for the APG to contain a provision that it will only become effective on receipt by the issuing bank of the advance payment together with the customers instructions to pay it to theexporter. Another way to protect your customers position is for the advance payment to be drawn from a letter of credit, conditional upon the presentation of the APG. Thus, the money ows one way as the bond goes the other. Of course, if you are drawing money from a bank in London and the bond is issued bya bank local to the customer then you will be faced with a difcult act of co-ordination. Ideally your APG should reduce in value by steps as each delivery or contractual milestone is achieved. Reduction mechanisms are described in Chapter6. A variation on the theme of an APG is a progress payment bond which, asits name suggests, is issued in exchange for a progress payment at an agreed milestone during construction/manufacture. If work to the value of the payments has been achieved, any requirement for a progress payment bond should be resisted, but it is not always possible to achievethis. A performance bond is designed to allow the customer to claim guaranteed nancial redress in the event that the exporter fails to perform the delivery and/or technical performance obligations dened in the contract. The contract will have set out the penalties/liquidated damages/compensation for direct losses incurred by the customer as a direct result of the failure of the exporter to perform or failure to remedy any default in accordance with the terms and conditions of the contract. The performance bond is an overt nancial obligation that is over and above these contractual remedies. It is common to see a requirement for a performance bond equivalent to 10% of the contract price. The performance bond will typically be required at the time the equipment is delivered and will run for either a set period (often 12months) or until some time after the scheduled completion or commissioning date for theproject. There is a tendency for some customers to require the performance bond to be provided at the same time as the APG. This should be resisted on the two important grounds of cost (to the exporter and hence to the customer via the selling price) and inappropriateness how can the exporter guarantee at the start of the contract the performance of equipment that may take many months or some years to deliver? If your arguments are not successful and you have to provide the performance bond at the beginning of the contract you should try to obtain some relief by having it conditioned such that it does not become effective and cannot be called until the equipment is delivered or commissioned in accordance with the terms of the contract. Of course, the wording needs to provide for the issuing bank to be advised of the occurrence of the trigger event(s). A warranty bond is given in support of an exporters warranty obligations, and its validity is likely to match the warranty period. It is typically issued in exchange for the expiring performance bond, although this should be specied in the wording to protect against the possibility of the customer holding both the performance and warranty bonds at the same time. Indeed, a good way to protect against this possibility is to combine the two bonds in a single document such that, for example, a 10% performance bond reduces to 5% upon completion of the contract works and then continues as a warranty bond until the end of the warranty period. This also reduces administrativecosts.
Chapter 1: What is an on demand contract bond?
A retention bond is similar to a warranty bond except that, unusually, it is a bond that might be volunteered by the exporter. If your payment terms involve a 5% or 10% payment which is retained by the customer for perhaps 12months after delivery of equipment, it may be preferable to offer a retention bond for the equivalent value in exchange for payment at the time you supply the equipment. The customer will have the security of knowing that he can recover his money in the event of failure of your equipment (much like a performance bond) but you may achieve a cost saving if the value of holding the payment for 12 months exceeds the cost of issuing thebond. An offset performance bond may be needed if, for a large project, there is a requirement to use locally sourced labour, materials or manufacturing during performance of the project, or if an investment must be made in local business. These Direct Investment Programmes (DIP) and National Investment Programmes (NIP) are important for a host government that needs overseas technology in a capital project but does not want to be seen to be favouring overseas business. It is important to have a robust mechanism for agreeing reductions to the bond value. If NIP is required, the offset performance bond is likely to continue until long after the contract is complete, simply because it will take time for the exporter to seek out suitable investments, negotiate the terms of the investment, and provide suitable evidence of thebenet. Standby letters of credit Some beneciaries prefer (and some banks can only issue) standby letters of credit (SBLCs) in lieu of on-demand contract bonds. SBLCs are standard banking practice in the US and in markets which follow US practice such as Taiwan and South Korea. SBLCs are a form of documentary letter of credit and perform in the same way as an on-demandbond. Under a payment letter of credit, the issuing bank agrees to pay against delivery of specied documents (e.g. invoices, bills of lading, warehouse receiptsetc.); Under a standby letter of credit, the bank undertakes to pay against presentation of specied documents which might be the beneciarys simple demand for payment. Many suppliers seek to incorporate additional documents to be delivered (if only copies) on drawing from the SBLC to reduce the chance of beneciary claiming the funds unfairly. A draft (an accepted bill of exchange) will often also be required. This draft is drawn up by the bank when the SBLC is setup. Documentary letters of credit usually incorporate the provisions of UCP 600 (Uniform Customs and Practice for Documentary Credits). However, UCP 600 is written for drawing payments when it can be demonstrated by documentary means that performance has been achieved, e.g. providing evidence of despatch in the format required under the letter of credit. UCP 600 does not always work well for SBLCs which are simply guarantees. This can lead to misunderstandings and disputed demands. For example, there is no mechanism in UCP 600 for reductions (such as when performance milestones are achieved or deliveries made), as would often be needed if the SBLC was guaranteeing AdvancePayments. ISP98 (International Standby Practices) rules have been designed specically for SBLCs. Some issuing banks will incorporate ISP98 into their SBLCs rather than UCP 600. ISP98 is designed to be compatible with the UN Convention on Standby Letters of Credit. ISP98 makes reference to choosing a governing law and states that the rules supplement the applicablelaw. 8 Chapter 1: What is an on demand contract bond?
An SBLC that is subject to English Law and issued by a UK bank has a distinct advantage in that it will expire automatically on its stated expiry date and on expiry does not have to be physically returned for cancellation. However, if the SBLC is silent as to the governing law, and particularly if it is issued by a non-UK bank, it can be difcult to get it cancelled. By comparison, URDG 758, the succinct and clear rule-set for bonds, has the advantage that it implies a governing law in the absence of any express statement (Arts 34 & 35). Some beneciaries see bonds as more exible with regard to the wording, and in allowing the opportunity to incorporate local law and receive a local guarantee. Choice over whether the guaranteeing instrument is a bond or an SBLC is very much a matter of tradition and practice. Certain countries favour SBLCs, conversely, other countries favourbonds. Extend or pay If contract performance is taking longer than anticipated or your customer is not yet ready to release you from your bonding obligation, an extension is likely to be requested. The phraseology used is rather harsh, but do not be alarmed it is quite normal to be told that your bond must be extended else it will be called. After all, if you do not extend the bond before it expires, the customer is left without its nancial guarantee of your goodperformance. When an exporter is supplying complex equipment and systems in sectors such as power transmission and distribution which can be difcult to commission successfully within the times originally set out for completion of commissioning, the importance of the performance bond is magnied because customers may need to submit repeated extend or pay demands under the bond and the exporter may need to extend the expiry date of the bond to allow more time for the non-commissioned equipment and systems to pass tests upon commissioning. In this circumstance, the act of extending the performance bond oils the wheels of the relationship between the parties at a time when a customer may view the performance of the exporter with some disdain and would otherwise contemplate terminating the contract due to the default of theexporter. ISP98 provides for extend or pay demands to be made, so there is very little difference between an SBLC subject to ISP98 and an on-demand bond subject to URDG 758 in this respect. See chapter 7 for more on the subject of extend orpay. Other forms of guarantee Bonds are an expensive instrument and it is worth knowing about some alternatives. In all cases, exporters recommend looking at the value of the contract and the importance of the buyer and asking do we really need to issue aguarantee? It is usual for a certain level of commercial protection to be included in the contract, in the form of penalties (liquidated damages) for delays etc. You will need to ensure that any additional letters/guarantees do not undermine them. Ideally, write into your contract that the sole remedies for delays and non-performance will be the liquidateddamages. If your own company/group is strong, the customer may accept a letter of comfort or a parent company guarantee instead of a bond. Offer your own preferred wording wherever possible, and allow time to get the wordings agreed with your customer in advance of contract award so that, if you are awarded the contract, you can move quickly to sign it and get towork. Chapter 1: What is an on demand contract bond? 9
A letter of comfort has no stated value, is off-balance sheet, and is intended to be morally comforting rather than legally binding. The letter of comfort might say that an ultimate holding company may assume the nancial risks of default in performance of a subsidiary company under a contract or commercial agreement, by the use of such wording as It is our policy to ensure that our subsidiary is in a position to meet all its contractual liabilities and we will not reduce our nancial interests in our subsidiary during the performance of the contract. Of course, in a prolonged recession, the value of a letter of comfort is questionable. It is always worth checking with a lawyer that the seemingly innocuous words of your letter of comfort are indeed not inadvertently binding your parent company into some form ofguarantee. A parent company guarantee is a legally binding obligation from a holding company that a subsidiary will perform the contract. Ask your lawyer to draft this guarantee. It is a good idea to include thefollowing: A clear maximum aggregated limitation of monetary liability which does not exceed the maximum aggregated limitation of monetary liability of the subsidiary under the contract and replaces the liability of the subsidiary, ie it does not create a new liability in addition to that of thesubsidiary. Clear expiry date No financial or other restrictive covenants Not assignable or transferrable to a third party Governed by English Law, disputes settled in the English Courts If your company is exporting as part of a joint venture, then your parent companys liability should be several (i.e. relating to your part of the contractonly). While it is preferable that the customer accepts your guarantee of the performance of your equipment, or a parent company guarantee, most customers require exporters to provide bonds issued by thirdparties. Bond issuers There are two broad categories of institution which issue bonds: banks and insurancecompanies. On-demand bonds tend to be issued by banks. They are willing to issue unconditional undertakings, under which they will be required to pay simply if requested to do so, because they will have passed the risk of having to pay back to the exporter by way of an indemnity. The bank marks the bond against the exporters overdraft / lending limit and also has to allocate its own capital to the exposure. Some banks have decided that there are more remunerative ways of using their capital than bonding lines, especially as contract bonds can be in place for a number of years. New Basel III banking rules will compound this by setting ever higher ratios of bank capital to exporter exposure. Larger companies tend to arrange, and pay a fee for, committed bonding facilities Surety bonds are issued by insurance companies and do not impinge upon the exporters overdraft facility. They are widely used in construction and civil engineering and often for 100% of contract value - to guarantee that the contractual terms will be fullled. The bond provides nancial protection for the beneciary against loss due to the inability of the
10
principal to discharge damages for breach of contract. Surety bonds can also be used to facilitate deferment of duty, for example to ease the cash ow for importers and exporters of petroleum, tobacco and alcohol. A surety facility is typically put in place with a maximum limit established by reference to annual audited accounts supported by management gures and budgets. Most surety bonds are conditional; the bond only being callable if the beneciary proves loss. The conditionality of surety bonds tends to be unattractive to overseas customers. (As this guide deals mainly with on-demand bonds, it does not really address conditional bonds issued by surety/insurance companybonds)
11
CHAPTER 2 THE CUSTOMERS VIEW Why should the customer want you to procure the issue of a bond or a series of bonds? Does he not trust you to perform your contract? If your customer is a public body that is engaging in a commercial transaction involving large amounts of taxpayers money, the answer is possibly yes: it is in the public interest of your customers country that taxpayers money should be protected. Just as you might seek to have the customer provide a letter of credit as a means of satisfying your shareholders that you are trading responsibly, so might the customer be required to show that contracts with overseas suppliers are undertaken with care. After all, if you perform your contract according to its terms, you wont have anything to worry about, will you? The point, in the customers eyes, of having a bond, is that it will provide protection in the event that you fail to perform the contract. The bond, in other words, keeps you honest. Your customer will want the bond to be provided by a third party because, at the time when there is cause to call the bond, the relationship between you and the customer may be fairly frosty; are you likely to pay recompense to your customer in circumstances where you are already not performing your contract? Of course, it may not be your fault that you are not performing your contract; political events may have intervened which prevent performance. But is that your customers fault? Why should your customer (which may be funded by taxpayers) suffer? Moreover, your customer might not even be happy to accept a bond from a UK or international bank because if, for example, you are unable to perform your contract obligations due to intervening political events, he might be concerned that a UK/international bank might also not be able to remitmoney. For this reason, your customer might be more comfortable holding a bond issued by a local bank in his own country which is much more likely to be able to full its obligations of delivering cash on demand than is the exporter or the exporters bank. In such cases, the local bank would normally have a back-to-back counter-indemnity with your UK/international bank, who would in turn be able to extract cash from your account if the local bank demands payment under that counter-indemnity. This diagram illustrates the relationships between the various parties: UK bank Counter-guarantee Local bank Bond Export contract UK exporter
Counter-indemnity
Customer (beneciary)
12
Chapter 2: The customers view
In this way the customer protects himself from the vagaries of international politics (in much the same way as the exporter might do by using credit insurance or having a letter of credit conrmed) and it is the local bank that accepts the risk of the UK/international bank being unable to pay if the customer calls the bond. Note however that the involvement of a local bank will inevitably increase the cost of bonding see Chapter 3. It would not be unreasonable for your customer to feel comfortable that the bank issuing the bond is accessible and good for the money. What could be more natural than for your customer to specify the local branch of his clearing bank? A government purchaser may require that the bond is opened by the State or Central Bank of his country. It is not unknown for government purchasers to request that bonds be issued by the State or Central Bank simply as a way of generating fee income for the bank. Now, this might be regarded as a refreshing example of joined-up government. Nonetheless, it would be wise to question any assertion along the lines of the law of our country requires bonds to be issued by the State Bank. The question should be asked of your bank, rather than your customer. If there is room for bonds to be issued by others then you may wish to draw your customers attention to the cost savings that would be made (and, of course, passed on to him) by having the bond issued by another, probably commercial, bank. Wherever possible, your customer should be encouraged to accept bonds issued by an international bank (that has establishments both in your country and its country) with a view to saving some fees. In any event, you can expect a sensible customer to be concerned with the credit risk of the bank issuing the bond. It is therefore quite common for the beneciary to require that the issuing bank is of a particular (minimum) credit rating. If this is starting to make depressing reading for the exporter, it should not necessarily be so. The customer is acting in a logical manner and in many ways simply mirroring our concerns in relation to his payment obligations. We should not be unduly concerned by this. There are two sides to the contract, after all. Your task is to reduce the subjective power of an on-demand bond in the customers hands and to try to ensure that it is only used justiably. If you can build a good relationship with your customer, you may nd that if you supply a bond from a reputable bank, of the right value and for an appropriate validity, you may be able to stand your ground on some of the nitty gritty of the applicability of clauses, validity etc.
Chapter 2: The customers view
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CHAPTER 3 THE BANKS VIEW It is important to price the cost of bonding into the bid, remembering to add an allowance for extensions for project delays or administrative difculties in obtaining release of the bond by the beneciary. If it is a sizeable contract and you, the exporter, have banking relationships with several banks, ask three or four for pricing and any security requirements, because each will have a different approach. In particular you are likely to see different appetites and pricing for larger bonds and those with longer validity. In pricing up a bond, the bank will take account of: 1. The exporter, its credit strength, reputation and experience, and how much of the banks overall credit allocation to the exporter is available for the bonding enquiry, plus the counter indemnity wording The quality and quantity of security provided by the exporter to the bank. It may be that the exporter is required to lodge cash to the value of the bond as security (but see item 7 below). The size of this transaction and volumes of other bonding business. The involvement of other banks. The wording of the bond is it robust and clear? The destination market and beneficiary. It may be that the bank will undertake a credit review of your customer. The possible use of UK Export Finance (ECGD) Bond Support. Current bank regulation on the amount of risk the bank takes on (known as the Capital Allocation requirement) Counter-guarantee
2.
3. 4. 5. 6. 7. 8.
UK bank
Local bank Bond
Counter-indemnity Export contract UK exporter
Customer (beneciary)
1. The banks risk on the exporter The exporters bank will take a view of the likely risk to its capital in the event that the bond is called and it has to pay the local bank under the terms of the counter-guarantee. The bank is protected by means of a counter-indemnity. How strong is the counter indemnity wording? Will the exporter have funds to reimburse the bank under the counterindemnity? Will the exporter be insolvent before the project is completed? 14 Chapter 3: The banks view
The bank will price the bond to earn a commercial rate of return on the capital which it has to allocate to the risk that the loan (resulting from the call of the counter-indemnity) will not be repaid. Effectively, therefore, the issue of the counter-guarantee to the local bank is treated as if it is lending to the exporter. The bank will view the bonding exposure as a part of its total exposure to the exporter. The bank will ideally evaluate whether the bonding line will enable the exporter to generate more business which will allow the bank to earn more in future. However it will always be subject to the overall lending limit including any overdraft, foreign exchange contracts etc which is likely to be set centrally. The bank will also need to take account of any further bonding requirements under the same contract, because the exporters failure to raise such further bonds could result in the current bond being called or, more likely, the bank being required to provide an additional bonding line in order to protect its existing exposure. 2. Security The bank might seek to mitigate its risk by requiring the exporter to keep cash on deposit to the value of the banks exposure, usually equal to the value of the bond. This can be a very heavy burden on the exporter, especially if there is a delay in getting the bond returned, as the bank would expect to hold on to the cash collateral until its exposure has been extinguished. Exporters should also be aware that the provision of cash collateral in this way might require waivers of covenants set by banks under unrelated borrowing lines. The provision of cash collateral in relation to advance payment guarantees, progress payment bonds and retention bonds should be avoided if at all possible because the whole purpose of such payments is to provide you, the exporter, with working capital and that working capital will not be available to you if you are having to deposit an equal amount of cash with the issuing bank. It may be possible to reduce the cash collateral requirement if the ultimate parent company of the exporter (if there is one) is party to the obligations in the counter-indemnity. But if the provision of cash collateral cannot be avoided, it might in some circumstances be worth considering accepting a smaller advance payment from your customer in order to reduce the size of the APG (but never go so far as not requiring an advance paymentat all). If the APG reduces pro rata to deliveries, make sure that any collateral requirement reduces likewise. UK Export Finance (ECGD)s Bond Support should be investigated if your bank requires cash collateral (see item 7 below). 3. Commercial pricing issues In addition to exporter risk, the bank will take a view of the volume of bonding transactions and the long term value of the exporter to the bank generally. The importance of the bank-client relationship will determine the banks pricing and willingness to issue the bond(s).
Chapter 3: The banks view
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4. Other Banks The bond is often required by the customer to be issued by a bank in the customers country. This prompts the question: Why should the local bank, which has no other involvement in the contract, issue an unconditional payment undertaking to the customer? It will do so for two principal reasons. First, it will earn a fee. Second, it will be protected by an indemnity from the UK bank which will say, effectively: If you [local bank] pay out on bond reference xyz then we [UK bank] will refund you. Do not assume that your bank will have a relationship with the issuing bank that is nominated by your customer. If you are lucky, your customer (the beneciary) will accept that the bond can be issued by the in-country subsidiary of an international banking group, or failing that, nominate a bank that has a correspondent relationship with your bank (the banks will have netting arrangements for the ows of funds between them). Some customers for example Government departments will have a short list of acceptable banks for issuing the bond, and some will insist that the bond should be issued by their clearing bank. Whatever happens, your bank will have to take account of its risk on the local bank. Bank regulation requires it to mark that bank risk. For very large bonds, your customer may require that the bond obligations are syndicated, i.e. that instead of a single bank providing its guarantee, a number of banks each provide a guarantee up to a certain level. This avoids bank risk concentrations for your customer. 5. Bond wording Banks appreciate that their customers operate in a highly competitive international marketplace and that it may not therefore be feasible to negotiate the most favourable bond wording. The bank will review the proposed wording of the bond: it will not want to be an arbiter about whether a bond call is valid. The bank will be looking for certainty: is it clear when the bond can be called? And what documentation will be required to do so? The bank is likely to ask that an authenticated list of signatories is lodged in advance. It may also ask for a pro-forma demand notice. Some guarantees include bond calls to be purportedly signed on behalf of the beneciary (or similar). Some guarantees require the beneciaries signatures to be authenticated by their bankers or a notary. It has been known that the bank requests evidence of signing powers after having received a demand! It is unusual to have beneciaries signatures in advance. However, if this was achieved, it would be prudent to append the signatures list as an annex to the bond, for example using the wording: Any demand hereunder must:be made in writing in English, on your headed stationery, signed on your behalf by one of the authorised signatories as shown on the specimen signature sheet attached hereto, addressed to us at the address set out above or at our registered ofce address for the time being, and will be deemed received on the next working day following delivery. The bank will also check the counter-guarantee and counter-indemnity wordings: it does not want to be in the position of having paid out on the bond and drawing on your cash but subsequently being required to return it to you.
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Ideally the bond, counter-guarantee and counter-indemnity wordings should be standard, and have an expiry date. The bank will not want to have an open-ended commitment. In some jurisdictions, however, expiry dates may not be enforceable. From the exporters viewpoint, the bond wording should ideally include: an expiry date expressed as a xed calendar date; that the expiry date is the latest date for the receipt of demands; and the bond is subject to a law and jurisdiction that will allow the expiry to hold good, such as English law and the exclusive jurisdiction of the Englishcourts. Your bank will be providing a counter-guarantee to the issuing bank. Bear in mind that there may be pressure for the counter-guarantee to be subject to local law and jurisdiction, and such law may not provide as much clarity as English Law in relation to the independence of the bond and validity of expiry dates. Your bank will normally only release you from your counter-indemnity when the overseas issuing bank has conrmed the release of liability under the counter-guarantee. It is important that your discussions with your bank are not left until after you have agreed the wording of the bond with your customer; it is possible that your bank will not be willing to arrange the issue a bond in the form negotiated with your customer. 6. Destination market and beneficiary Your bank will have appetite limits on overseas markets, and may also review the customer. There could be reputational issues for the bank. 7. Bond Support from UK Export Finance (ECGD) After much pressure from BExA, the Governments Export Credit Agency, UK Export Finance, agreed in 2011 to provide bond issue support. This enables the exporters bank to allocate a portion of the exporter risk as UK Government risk, thereby allowing more breathing space in the bonding limit. This can have the effect of reducing pricing, for example if the exporters bond pricing varies according to usage of credit facilities. It can also help with very large bonding requirements if your bank is acting in a structuring capacity and engaging other banks to provide funding. Bond Support adds security to the bonding line from the bank, and, using it, an exporter should be able to negotiate improved facilities in terms of the wording of the counter indemnity and/or the security requirements. In relation to advance payment guarantees, in cases where the bank requires cash cover, UK Export Finance Bond Support should enable the cash security to be signicantly reduced.
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UK Government Bond Support A growing UK engineering company needed to guarantee its export contracts by providing bonds. A typical contract might involve: An APG to the value of the mobilisation payment, valid until delivery 10% Performance Bond valid for the duration of the contract (6 months to 2 years) 10% Warranty Bond valid for the duration of the warranty obligation (1 to 6 years) Export growth meant that the company needed an ever-increasing bonding facility. UK Export Finance (ECGD) Bond Support provided additional capacity through supporting Performance and Warranty Bonds by up to 50% and APGs by up to 80%. To be eligible for the support, the UK content of the export needed to be at least 20%. Bond Support enabled the exporter to bid for more contracts in the knowledge that, in the event of being awarded the contract, there would be capacity to arrange the required contract bonds. Particularly with regard to APGs, Bond Support also meant that the bank did not needhave suchstringent capital weightings because of the guarantee in placeby UKEF and therefore pricing was reduced. 8. Capital Allocation The bank will need to price in an element to reect the capital allocation necessary for the type, size and duration of the facility. Fees for bond issue The cost of bonding is one of those hidden items which all too often are ignored; ignored by the customer, at any rate, as it is the exporter who pays the banks fees, even though the exporter will pass the cost on to the customer in the contract price. There is no standard cost. A UK bank might charge between 0.5% and 3% of the value of the bond per annum, depending on its assessment of the exporters nancial strength and its willingness to allocate its own capital for bonding lines. A minimum fee will often be specied which, for low value bonds, could have the effect of increasing the cost as a percentage of the bond value. These charges will apply until the bond is returned for cancellation (which could be some time after the specied expiry date). If the bond has to be issued by a local bank, it will also be necessary to add the fees being charged by the local bank at least 1% per annum in addition (see Chapter 4). The two charges may be shown as a single fee or be itemised. This can make for quite a bulky fee if the bonds are expected to be valid for a number of years. Fees may be charged in a variety of ways. The most usual is quarterly in advance or in arrears for the UK bank but with an up-front fee for the local bank.
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Banks know that, once they are supporting a bond, it can be difcult to extract themselves from that support (particularly as bonds have a habit of being extended) whereas other banking offerings allow more exibility the bank can more easily stop lending, for example, if the risk deteriorates. Bonding is therefore often regarded by banks as relatively un-remunerative when compared with other uses of their capital. Practicalities In most circumstances it will not be possible to obtain your ideal wordings and features: your contract will be a negotiation and you may have to accept some compromises in relation to the bonds. While the bond is in place, the bank has a liability to pay. Some jurisdictions allow bonds to be cancelled on expiry, however others will allow the bond to be called on presentation. In these countries, or with bonds subject to these jurisdictions, the per annum fee will continue to be charged and the bond count against the exporters credit limit until the bond has been physically returned, regardless of the expiry date on the bond. It is in your interests to achieve the return of the bond to the issuing bank (and the return to the UK bank of the UK banks counter-guarantee to the local bank) in order to put an end to the payment of fees and the use of your borrowing limit. A requirement for the customer to procure return of the bond should be included in the contract of sale. Where a bond has to be extended, the bank may ask for more security as well as increased fees. The counter-indemnity The UK bank will always require the exporter to provide a counter-indemnity which gives it the right to recover from the exporter all sums that it has to pay out under the bond. Such a counter-indemnity will often cover the followingpoints: In consideration of the bank agreeing to issue [the bond] the exporter agrees 1. To indemnify the bank against all claims, demands, liabilities, costs, charges and expenses which may be brought or preferred against the bank or which the bank may incur arising out of or in connection with the bond The bank or the local bank, as the case may be, may pay the beneficiary or any other party entitled to receive payment any amounts demanded from the bank or the local bank, as the case may be, under the bond in accordance with its terms To pay the bank [within x business days of] [promptly on] demand an amount equal to all sums so paid by the bank or by the local bank The bank may debit any account in the exporters name with any sums payable by the exporter A certificate of an officer of the bank stating the amount which the bank is entitled to demand at the date mentioned in the certificate and stating the amount the bank is paying in accordance with the terms of the bond shall, in the absence of fraud and manifest error, be conclusive evidence of the amount which the bank was entitled to demand at suchdate Chapter 3: The banks view 19
2.
3. 4. 5.
6.
The bond issued by the bank or the local bank to the beneficiary or the indemnity issued by the bank to the local bank shall be subject to the appropriate law, jurisdiction, usage, custom and terms of whatever nature required by the bank or the local bank The counter indemnity is a continuing indemnity and shall extend until the ultimate balance of all amounts payable by the exporter under the counter indemnity are paid in full and shall continue until the bank is under no further actual or contingent liability under or in connection with the bond as determined by the bank acting reasonably and in good faith provided that the bank will be deemed to be under no further actual or contingent liability under or in connection with the bond if the bank is advised by independent legal counsel of recognised standing that the bank is under no further actual or contingent liability thereunder Neither the bank nor the local bank shall have any liability or responsibility for any delay, loss in transit or error in translation or transmission of messages sent or received in connection with the bond itself except to the extent that such arise out of the negligence of the bank or the localbank The counter indemnity shall be governed and construed in accordance with English law and any dispute concerning the counter indemnity shall be settled in the English courts.
7.
8.
9.
MAC clause Some banks will include a Material Adverse Change (MAC) clause for protection in case the exporters solvency risk deteriorates. The impact of this will be that breach by the exporter of MAC conditions as to assets, operations, prospects or nancial condition will result in the bank re-negotiating the line, for example requiring cash security or increased pricing. Large bonds What happens when an exporter is fortunate enough to win a contract that is so big that the required bonds are more than one bank is prepared to issue? This might happen even where the bank theoretically has a sufcient bonding limit but chooses to spread the risk, and not put all its eggs in that one basket. Solutions may include: The bank could share the risk with one or more other banks. Sub-contractors and major suppliers can be asked to participate in the indemnity that will be given to the issuing bank UK Export Finance (ECGD) Bond Support may be preferable to the bank so that it can manage the whole relationship with the exporter, its client.
If risk sharing is required with other banks, then, regardless of the number of banks involved, there are two main ways in which the risk is shared among the banks: by risk participation or by syndication.
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Risk Participation for large bonds Under this arrangement, the exporter issues a single counter-indemnity to the issuing bank. The issuing bank enters into a risk participation agreement with the other banks (the sub-participant banks) whereby if the bond is called and the issuing bank has to pay, but if the exporter does not honour its counter-indemnity, the issuing bank approaches each sub-participant for re-imbursement of its share. Customer (beneciary) Issues bond Issuing Bank Counter-Indemnity in favour of Issuing Bank Exporter
Bank A Bank B
Indemnities in favour of Issuing Bank Bank C Bank D Sub-participants
This arrangement has advantages: The issuing bank can sub-participate the risk before or after the bond(s) have been issued. If the risk is sub-participated afterwards, then the issuing bank has in effect accepted an underwriting risk and will expect a fee for doing so. The documentation is relatively simple. The exporter only has to deal with one bank (the issuing bank). The principal disadvantages: The sub-participant banks have no direct contractual relationship with the exporter and therefore they rely on the issuing bank recovering any monies from the exporter. Therefore each sub-participant bank has an exposure to the issuing bank. Syndication of large bonds Under this arrangement the exporter counter-indemnies each of the banks in the syndicate (the syndicate banks) separately for its share of the bonding risk as well as the issuing bank. In other words, unlike the risk participation structure there is also a direct contractual relationship between the exporter and each syndicate bank.
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Customer (beneciary) Issues bond Issuing Bank
Counter-Indemnity in favour of Issuing Bank Bank C
Bank A
Bank B
Counter Indemnities in favour of syndicate banks
Exporter
The principal advantage of this arrangement is that: The syndicate banks are not taking a payment risk on the issuing bank. The principal disadvantage is: More paperwork! The documentation can be more complicated and the process can take longer. Under both the risk participation and syndication arrangements, the issuing bank takes a risk on the underpinning bank group. Each bank will have a limit on the amount of credit on any other bank. The issuing bank will charge a fee, usually referred to as a fronting fee, for taking this credit risk. As well as an arrangement fee, there might be an annual management fee payable by the exporter to the issuing bank in order to cover the bureaucracy of collecting and then paying out the bonding commission to the other banks according to their shares. So, the costs of this type of exercise mount up; all the more reason to build these costs into the contract price. It is important to nd a lead bank with the necessary experience and a successful track record of handling this type of arrangement. In this way the costs referred to above can be quantied in advance and built into the contract price. A good relationship with the lead bank is essential: it will be doing a lot of work on behalf of the exporter. By denition, if more than one bank is required for the bonding, the contract will be a large one for the exporter. It will occupy resources and attention and will be important to the exporter (and the banks). The nal stages of negotiation (with the customer) of contracts of this nature can generate a degree of what might be called dynamic tension. Try to avoid a last minute scramble where everyone is so excited about winning the contract that they have forgotten about the bonds in particular, do try to involve the issuing bank at the earliest possible stage to review the bond wording and the costs associated with issuing such bonds, especially on a multi-bank basis.
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Chapter 3: The bank's view
CHAPTER 4 THE EXPORTERS VIEW Why does the exporters view come after those of the customer and the bank? This is, after all, supposed to be a guide written for the exporter. The reason is that it is not possible to discuss the exporters view without an understanding of the positions of the other players in this game. The banks are not obliged to issue bonds for us. The customer has the option of saying no bond, nocontract. Should you offer a bond to anyone thatasks? The short answer is no. Bonding is costly, albeit your estimate of costs will be included in your contract price and thereby paid by your customer (although if the customer fails to return the bond for cancellation, the overrun costs will not have been included in the Contract price). If price is an issue for your customer, reducing the bonding requirement will surely be anadvantage. From your perspective, bonding will tie up your banking lines for the entirety of their validity (which may exceed the intended validity period). And then there is the risk of bond call. Assuming you have performed your contract satisfactorily, you will not expect your bond to be called, but the good relations with your customer at the start of the contract may be overtaken by changes in your customers nancial or political standing over the year or years of contract performance. A commercial customer may be bought out or become insolvent; a government customer may be subject to a new political avour that no longer requires your project to be completed. You may see a hiatus in your relationship and you may nd that your customer uses the existence of the bond to encourage you to deliver 110% of what you contractually agreed todo. However, bonding is a feature of many public sector contracts and increasingly in developmental contracts for private sector contractors. Ideally, therefore, take advice before agreeing to provide a bond. Ask your credit insurer for unfair calling cover (including insolvency cover if your customer is private sector) to increase your level of comfort in issuing thebond. Putting the bond in place How do you go about arranging a bond? It is unlikely that you will have a relationship with the customers nominated bank. It is more likely that you will have to ask your UK relationship bank to issue the bond or to arrange for the local bank to issue the bond. If you are lucky enough to have more than one UK relationship bank, the choice of bank may in part depend upon which UK bank has a relationship with a suitable localbank. If the customer has not nominated a particular bank you are able to start from this end, as it were, by choosing a bank with which you are happy to dobusiness. If local issuance is required by your customer, you should obtain from your bank a list of local banks with which it is happy to deal. You can then suggest to your customer one (or more) of these local banks as a potential issuer of the bond. If your UK bank has a branch in the customers country it would be natural to suggest using that branch to issue the bond. The cost to you should also be less than involving a second, completely different, bank in thetransaction.
Chapter 4: The exporters view
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Cost of bonding As we have seen, the cost of issuing a bond will vary considerably. It will tend to be the case that large, well capitalised, companies can drive a harder bargain with their banks than smaller companies. This is a fact of life. The cost of bonding will follow this general rule. Whatever the rate per annum, it is important that the exporter builds into his price the cost of bonding as with any other contractcost. Let us assume that you are required to procure an APG and a performance bond. Your contract is priced at 10 million. The advance payment (and hence the APG) is 15% of this sum and the performance bond is set at 10% of the contract price. The APG is required to be in place for the period between receipt of the advance payment and delivery of the equipment in a single lot 24 months later at which time the performance bond is to be put in place, valid for 12 months. Your bank has told you that it will charge you 1.5% per annum. The rst calculation to dois: APG 10 million x 15% x 1.5% x 2 years = 45,000 Performance bond 10 million x 10% x 1.5% x 1 year = 15,000 The total is 60,000 so far. You can expect a local bank to add another 2% per annum, another 80,000, for a total of 140,000. It may be that you are a little late in delivering the equipment; the customer will not release the APG until he has taken delivery of the goods. What happens if you are not able to recover the bonds when they expire? The banks will continue to charge you. Allow a further 6 months to recover the bonds; this may seem like a long time but some customers are adept at holding on to expired bonds knowing the value that they have to us. This may be done in an effort to make negotiations for a subsequent contract more interesting (i.e. to give the customer another bargaining chip). It may simply be that the customer has lost the bond; it does happen. In this case the bank will be reluctant to release you from your obligation and will continue to charge you until you have obtained a written statement from the customer that you and the bank are released from all liability under the bond; you may imagine how easy it is to get your customer to give such a release. Hence, build in to your price an allowance for a delay. Banks tend to charge for bonds by the calendar quarter. The extra six months will add this to thecost: 10 million x 25% x 1.5% x = 18,750 for your bank and 10 million x 25% x 2% x = 25,000 for the local bank 43,750 in total. Your bonds are now costing 183,750 or 1.84% of your contract price in bank fees alone. You may choose to insure your bonds against the risk of them being called unfairly. We will look at this insurance in Chapter 9 but for our present purpose we can say that the premium for these bonds could conservatively add a further 26,250 (assuming a premium rate of 0.5% per annum) bringing the grand total to 210,000 or 2.1% of your contract price. You should not draw from this the inference that bonding will cost you about 2% on any contract. The calculations are not complex but they do have a number of important variables, not least the fee that the banks will charge you. You may wish to re-do the calculations to see the impact of bank charges at 2.5% per annum. Bonds issued in some countries, Turkey for example, will also attract stamp duties and taxes (refer to Appendix 2 for someexamples). 24 Chapter 4: The exporters view
Now, the nal gure might or might not be difcult to accommodate within your price. The point is that it should be accommodated. You cannot afford to disregard the cost because such a contract specic cost can only sensibly be recovered from the contract. Better that you include it in your price than you deduct it from your prot on thecontract. It is worth stressing that although we have used a gure of 10 million for a contract price the principles outlined will apply whether your contract is priced at 10 million or 10,000. Further, it may be that the value of your bond is small and that the effective cost (because of the impact of minimum fees) is disproportionately high. In this case, it may be worth offering to the customer a price reduction in exchange for not having to procure thebond. The cost of a small bond - UAE A maintenance services contract was signed with an Abu Dhabi government department in 1996. Performance was guaranteed by a 6,600 bond issued through a UAEbank. The bond came to light some years later as part of a review when the exporter was bought by a larger corporate, by which time many of the people involved had left the company or retired and were unable to help put the jigsawtogether. It was clear from the archive that the exporter believed that the contract was fully fullled, so someone was tasked to contact the customer and argue for the cancellation of the bond. The customers records told a different story that the exporter had not performed to expectations and that some liquidated damages were thereforedue. Although the release of the small bond was low priority, it had been racking up bank charges of between $500 and $1,000 each year. The exporter decided the best plan was to have the bond called and draw a line under the episode. The customer, however, had other plans. After some delay, the customer calculated a value for the claim - 4,800 and made a partial call of the bond. This happened in February 2012 and the release of the 1,800 balance of the bond value happened a month later. There are no shortcuts in getting a bond released,unfortunately. Risk of bond call Now, from cost, to risk. We have seen that in order for the bond to have value to your customer it must be payable on demand. Your customer does not have to prove or demonstrate that you are at fault. Your contract may state that the customer shall not make a claim under the performance bond except for amounts to which the customer is entitled under the contract in the event of the occurrence of a number of dened events. However, because the bond is on demand, your customer, the beneciary of the bond, is able to avail himself of the proceeds thereof, not only if you have failed to perform your contract but also for no good reason atall. The customer does not get a free ride, however, if the bond is called unfairly. If you have used standard contract terms such as FIDIC 1999 General Conditions of Contract, these include that the customer is required to indemnify and hold the exporter harmless against and from all damages, losses and expenses (including legal fees and expenses) resulting from a claim under the performance bond to the extent to which the customer was not entitled to make theclaim. Chapter 4: The exporters view 25
In other words, the call on the bond may be fair (by reference to your delinquent performance of the contract) or unfair i.e. you have performed admirably but your customer calls the bond regardless. It should be said that it is rare for a beneciary to call a bond unfairly. However, because it is a rare occurrence does not mean that we should disregardit. Perhaps the most unquantiable of the risks is political risk including the risk that you are unable to perform your contract because your export or import licence has been revoked or not renewed or sanctions have been imposed, or a war or a natural disaster has occurred that means you cannot physically complete the contract. There is also the risk that a change in political sentiment in the destination country leads to an incoming government not wanting to continue with a contract and perhaps creating difculties that prevent properperformance. It is possible to protect yourself from the risk of a bond being called unfairly or for political reasons by buying unfair calling insurance. We will consider this more fully in Chapter 9 but for now it is worth making the point that your bond can be called, and if it is called you can expect it to be paid by the bank straight away, and for the bank to claim on your counter-indemnity, and all of this without reference to your to performance of thecontract. The cost of conditionality - Bangladesh A 30,000 performance bond was issued in 2001 via a Bangladeshi bank to a Bangladesh government department. It was to be valid for 24 months and supported an engineeringcontract. The UK exporter managed to achieve some non-standard conditionality in the wording. Any bond claim was subject to the beneciarys statement that the supplier has failed to comply with the terms and conditions of the contract provided that it is counter-signed by the supplier. The exporter would have felt protected against an unfair call of the bond, but most probably did not anticipate the cost to the business of this bond over the nextdecade. A more regular clause was included concerning extensions in case of delays to performance: the bond could be extended if desired by the beneciary and communicated in writing as such to the localbank. As in most developmental engineering contracts, there were technical challenges to resolve before obtaining nal acceptance from the customer, however the issue that caused dissatisfaction by the customer was outside the scope of the UK exporters contract. The customer tried several times to call the guarantee to which the UK exporter argued successfully, through its UK bank, that the call would be invalid/fraudulent without the countersignature of theexporter. The result was that the customer extended the validity of the bond, and the bank fees of doing so ate into the prot on this contract and more. After 9 one-year extensions and several trips to Dhaka, each costing the company over 5,000, and engineers xing the problem, even though there was no contractual obligation to do so, the exporter nally obtained nal acceptance from the customer who was able to instruct the local bank to release the guarantee on 20th March 2012... It could have been cheaper to let the bond to be called earlier in the process but customer relationships areparamount.
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If one had to select only one item of protection to put in a bond wording it would probably be the inclusion of an expiry date. Unfortunately, and even though an expiry date should still be included, this is probably the one aspect on which there is greatest disagreement between the laws and practices of different countries. In a few countries an expiry date under local law is unenforceable and of no effect; in others enforceability is uncertain, sometimes because of confusion with the limitation periods for general contracts ruling in those countries. Whatever the reason, UK issuing banks have taken the view that they will disregard an expiry date unless the bond states that it is governed by English law and is subject to the exclusive jurisdiction of the English courts. Without this safeguard, the banks will continue to hold exporters liable until the actual bond document is returned to the issuing bank for cancellation. If the bond has been issued by a bank in the customers country, the exporters bank may insist on waiting until its counter-guarantee has been cancelled before releasing the exporter from liability. You may need to encourage your bank to undertake the process swiftly. If the bond is issued by a foreign branch of your UK bank, it should be relatively easy to understand if the overseas branch will observe the expiry date and release your bank from its counter-guarantee. This extended tying-up of an exporters banking facilities and the nancial risk as well as the continuing bank charges can combine to be very disadvantageous to an exporters business, particularly in the context of confusion surrounding the true legal position in different countries. This was realised and understood by the United Nations Commission on International Trade Law (UNCITRAL) which drafted a Convention to stop these abuses. Appendix 3 gives more details. To date, the UK Government is taking no steps to introduce these UN safeguards. However, a handful of countries have ratied the Convention and this can be helpful to exporters who have to raise bonds for customers in thosecountries. Remember that while your bond is in the possession of the beneciary it will be counted against your banking facilities and the bank will continue to charge you fees. This may be long after you have completed the contract to which it relates. It is thus in your interest to have the bond returned to the issuing bank and to have that bank release the guaranteeing bank from its counter-guarantee and to have your bank release you from your counterindemnity. It is only when that is achieved that the value of the bond will stop being counted against your bank facilities. You will need those facilities to support the issue of your nextbond. Unnecessary use of your precious bank facility and additional costs are not the only reasons for working hard to have the bond returned. Your customer would be very happy to have another item on the agenda when it comes to discussing the next piece of business, particularly an item that he knows you need. Put simply, if you are in the position of having to achieve the return of an expired bond from your customer when you are about to start discussing a subsequent order you have handed him a negotiating point that will make your life harder. So, when a bond expires try to get it returned to the issuing bank as soon as possible. A contractual obligation requiring the customer to return the performance bond to the exporter within seven days after the exporter has become entitled to receive a performance certicate is a useful provision, although it may be breached rather more often than it isobserved.
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Joint ventures In the event that a bond is required to support the activity of a joint venture company that is owned partly by you and partly by another company, any counter-indemnity from you to the bank should be structured in such a way to ensure that your liability is of a several nature and consequently restricted to an amount which is directly proportionate to the shareholding which you have in the joint venture company. You might want to add the following words or similar to your counter indemnity to thebank: provided further that our total liability hereunder shall be limited to [ ]% of the liability under the bond, it being agreed that the other [ ]% is the subject of a separate counter-indemnity(ies) between the bank and [insert the name of the other shareholder(s)] Bond watchlist: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Beneficiary should have to state a reason for calling the bond Bond should not be transferable Include a no interest clause Should state which law applies to it APG effective only on receipt of the advance payment APG reduction automatic, pro-rate to deliveries Bond should not top up when called in part Call should be signed by two people Expiry: date preferable toevent. Require the original to be returned to the bank onexpiry.
This watch list was used in export credit insurance training by Richard Hill, the editor of the original BExA BondGuide.
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CHAPTER 5 THE LAWYERS VIEW In contracts of sale, exporters are often required by customers to guarantee or warrant good performance or of the quality of goods supplied. This type of guarantee is a part of the exporters obligations under the contract and is very different in nature from a guarantee or bond which is issued by a separate party such as a bank or insurance company because, when such a bond is called, the exporter has to indemnify the bank or insurance company which increases its contractualliabilities. The bank or insurance company issuing the bond does so by means of a document which is legally separate from the contract of sale. This separation of the bond (particularly when on-demand) from the contract of sale is the fundamental starting point for English case law on the subject (and in most other systems of law). The effect of this is that the wording of the on-demand bond will be looked at by a court as if it was in a watertight box and no account will be taken of the situation under the separate contract ofsale. There is at least one other separate document involved when an on-demand bond is issued by a bank. Because the bank does not wish to be out of pocket if it pays on a demand, it will have in place a counter-indemnity signed by the exporter entitling the bank to be reimbursed from the exporters account. In practice, the funds may well be ring-fenced by the bank either from the exporters deposits or its overdraft facility, in either case clearly affecting the exporters ability totrade. The exporter should pay attention to the wording of the counter-indemnity which he is required to sign even though it will probably come in standard form. Banks will often require exporters to agree to reimburse them for a payment under an on-demand bond whether or not the payment was validly made. Exporters should try to insist that they are liable only if the payment by the bank was made strictly in accordance with the terms of the wording of the bond itself (particularly important if the customer insists on the bond being issued by his local bank). This is more easily said than done,however. The concept that the on-demand bond and its associated documentation are all separate and distinct from the contract of sale was illustrated in one of the formative English Court cases2 (decided in 1978). An exporter of greenhouses instructed his bank to arrange for the issue of an on-demand performance bond for 10% of the purchase price in favour of his customer. Under the contract, the customer was required to open an irrevocable letter of credit in favour of the exporter conrmed by a named UK bank. The customer failed to do so and the exporter refused to supply the goods. The customer claimed under the on-demand bond and the English Court of Appeal refused to grant an injunction to stop the bank from paying the bond. This meant that the exporter was required to reimburse itsbank. What the Court said was: A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the
2
Edward Owen Engineering Ltd v Barclays Bank International Also Cargill International v. Bangladesh Sugar and Food Industries Corp (1996)See also Enka Insaat Ve Sanayi v. Banca Popolare Dellalto Adige SPA 2009 (EWHC 241). F+R, a UK subcontractor to a Turkish company, was supplying a Russian company that terminated the supply contract and F+Rs bond was called even though there was no issue with non-performance.
Chapter 5: The lawyers view
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question whether the supplier has performed his contractual obligations; nor with the question whether the supplier is in default ornot. Although the on-demand bond has to be considered separately from the contract of sale, this does not mean that the contract of sale is unimportant in this context. The following issues will illustrate how the contract of sale can help (or harm) the position under thebond: i) The clause in the contract which requires the exporter to arrange for a bond to be issued should be clear and precise about what is required. It should give details of percentage values of each bond, how they are to be reduced, what event starts them off and what event finishes them, which banks are involved and expiry dates. The actual wording of each bond should be appended to the contract and safeguards for the exporter should wherever possible be negotiated into the wording. It is very easy for the bond wording to be dismissed as the banks responsibility; however, it should now be clear that in fact it could be crucial for the financial outcome of the contract for theexporter. If more than one bond is to be issued under the same contract, care should be taken to see that they do not overlap and cover the same risk simultaneously. For example, an advance payment bond, a performance bond and a warranty bond have potential for an overlap which should be avoided. Sometimes a performance bond has to be issued before a tender bond has been cancelled; one way of avoiding double risk is to state in the performance bond that it will come into effect only when the tender bond document has been returned to the issuing bank forcancellation.
ii)
iii) The inclusion of an appropriate effectiveness clause in both the contract and the bond could have avoided the problem identified in the court case described above. An effectiveness clause delays the coming into effect of a contract until specified events have occurred. One such event should have been the receipt by the exporter of a letter of credit in the form specified in the contract (or in a form acceptable to the exporter). The performance bond should in turn have specified in its wording that it would come into effect only when the contract came into effect. This illustrates the way an exporter can establish a link between the two documents, the contract and the on-demand bond, which English law otherwise treats as entirelyseparate. It should be noted that if the exporter applies for an injunction (to restrain the beneciary from making a demand or the issuing bank from paying out), the English courts will generally only grant the injunction where the demand is fraudulent and the court is satised that the issuing bank knows that the demand is fraudulent, or if the circumstances are such that the only reasonable inference is that the demand is or will be fraudulent. In the case of Simon Carves Ltd v Ensus UK Ltd [2011]3, the judge said if on a commercial contract in which there is a bond in favour of the beneciary party, the parties reach a full and nal settlement which expressly requires the bond to be returned to the other party and no further calls to be made to the bond and (in this circumstance) the beneciary party seeks to call on the bond, in breach of the settlement terms, the court could properly restrain the beneciary from doing this either because it is committing a straight breach of contract or because it is or should be taken to be clear fraud by thebeneciary.
EWHC 657 (TCC) Akenhead,J
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Of course, this all depends on whether the bond is really a bond! Some bonds can be badly worded especially if you are dealing with a customer who insists on using its standard form wording. Consequently, some bonds can inadvertently be guarantees in their truest legal sense (irrespective of what the document is actually called) in that the issuing bank guarantees the obligations of the exporter under the contract (rather than undertaking to pay on demand). This means that the English courts (who look at the actual construction of a bond, not just at what it is called) may come to the conclusion that a bond is really a guarantee such that (in certain circumstances) a demand under such guarantee is not enforceable if for example the underlying contract turns out to be unenforceable. This situation is not helped by the fact that some bonds are called guarantees, bank guarantees or independent guarantees but are not (in law) guarantees at all. At rst reading, one might think great, we could have a get-out but in reality this uncertainty only leads to ambiguity and confusion, and hence the courts. This is rarely to be recommended, and if the issuing bank incurs any costs in connection with litigation relating to a bond it will always look to the exporter for reimbursement under the counter indemnity if all its costs are not recovered through the courts (which often they are not). Exporters therefore recommend getting the wording of your bonds right and seeking the help of your issuing bank at an earlystage. Make use of International rules It is best not to leave the wording of important documents to the imagination of your customer (the beneciary), so make sure that the following are activated by the wording of the bond orSBLC:. Bonds: URDG 758 to add clarity and conrm that the bond is independent SBLCs: ISP 98 in preference to UCP 600. Use ISP 98 model forms for demands, extensions, reductions and counter-indemnities or ISBP 2013 standards for examination of documents if the SBLC is subject to UCP600. The ICC publishes a comprehensive study on the legal framework for contract bonds: Bank Guarantees in International Trade by Roeland FBertrams.
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CHAPTER 6 WHAT TO WATCH OUT FOR AND WHAT TO AVOID Watch-out list Experienced exporters recommend a bond should contain the following features: i) if issued in advance of the contract, the bond should become effective only when the underlying contract becomes effective and, if appropriate, the advance payment has beenreceived; a calendar expirydate; reference to the contract to which itrelates; a limit on the aggregate nancialexposure; for APGs, a reduction in the nancial exposure in proportion to the value of goods delivered/services performed; a requirement that the beneciary has to state a reason for calling the bond and give time for the exporter to rectify the allegedfault;
ii) iii) iv) v) vi)
vii) that any demand for payment to be signed by an authorised signatory (preferably two) of the beneciary and for the signature(s) to be authenticated; and viii) to which law it is subject and which courts will have jurisdiction to settle anydisputes. Let us consider these points inturn. i)If issued in advance of the contract, the bond should become effective only when the underlying contract becomes effective and, if appropriate, the advance payment has been received The ideal arrangement is for no bonds (other than a bid or tender bond) to be issued before the contract is signed. If the contract has conditions that need to be fullled before it becomes effective and thus commits both parties to its performance (for example the opening of a letter of credit or receipt of a down payment within a specied period), then these conditions should also apply to thebond. If the bond is an APG, then the receipt by you of the advance payment should be included in those conditions relating to validity. As the advance payment is handed over so is the APG. The transfer of the funds and the APG is a matter of banking procedure. It may be that the bond is received by the customer before you receive the advance payment (especially if a local bank issues the bond) and in these circumstances it is wise to include an effectiveness provision in the wording of the bond to avoid the risk of the bond being capable of being called before you have received the advance payment or even have an effective contract (see also paragraph (c) in Chapter5). ii) The bond should have a calendar expiry date Whatever provision you make for the expiry of the bond, it is always worth adding a phrase along the lines of but in any event no later than 31December20--. While it may be simple to establish that you have performed the contract, delivered the equipment, successfully reached the end of your warranty period etc, there is always the possibility that you will be
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Chapter 6: What to watch out for and what to avoid
unable to perform your contract for reasons outside your control. Whatever happens, the calendar date will arrive. Your customer might feel aggrieved if your no later than date fell only a short while after your forecast completion date so it is common to allow six months or a year beyond the date that you expect your contract to be performed, warranty period to expire or whatever in order to give your customer a degree of comfort that if you do not complete on time he does not necessarily have to have the bond extended. Remember, the purpose is to introduce a degree of certainty into the expiry date, not to short-change yourcustomer. The statute of limitations does not apply to bond expiry dates! Unless it expires, the bond will carry on indenitely, and you, the exporter, will have a good deal of bank charges to pay. Experienced exporters recommend that the calendar nal expiry date is shown on the original bond document and any extensions. There have been cases where a bond has been extended several times, and papers can become detached andmislaid. It is a good idea, before appointing the bank, to ask for its policy on expiry provisions and return ofbonds. On expiry of a bond issued by a local bank, the bond will need to be returned to the (overseas) issuing bank, not to your (UK) bank. A written statement from the beneciary conrming that the bond has expired can be used to negotiate the release from liability under the counterindemnity. If the bond states that it is subject to URDG758, there is the advantage of Article 25 which states that the bond will expire on the stated expiry date. See Chapter 10 for more on thissubject. At this point, it might be as well to cast an eye over Appendix 2 which sets out some examples of the way in which the laws of other countries deal with expiry dates and other bond issues. Whilst a degree of certainty is the aim, it cannot beguaranteed. Many exporters are so concerned by this uncertainty about expiry dates that they propose a standby letter of credit (SBLC) instead of a bond. The SBLC can have all the features of an on-demand bond yet it is written in the form of a letter of credit and should be expressed to be subject to ISP98 or perhaps UCP600. ISP98 Article 9 states that the standby must contain an expirydate. iii) The bond should contain reference to the contract to which it relates Even though English Law assumes that bonds are independent, and issuing banks like bonds to be independent, exporters recommend that the text of the bond should always clearly specify the name, general description, contract or tender number and the date of the underlying contract. If you can tie the bond to your contract, including its horizons, milestones and denitions, you will improve your control of thebond. iv) The bond should contain a limit on the aggregate nancial exposure A limit on exposure (i.e. the value of the bond) is something that your bank should insist on. It is good practice to place an explicit limit on any nancial exposure. The point is really made in connection with avoiding top-up bonds (see item (x) below) but also applies tointerest. v) APGs should contain a reduction in the nancial exposure in proportion to the value of goods delivered/services performed An advance payment (i.e. money paid by your customer at about the time the contract is signed or becomes effective) is requested for a number of reasons. Often, but we might not always mention this to our customer, we want some evidence that our customer has the wherewithal to perform its side of the contract or at least demonstrate a commitment to the contract. Generally Chapter 6: What to watch out for and what to avoid 33
we will explain our desire for an advance payment in terms of needing mobilisation money, something with which to start manufacturing. So, as our customer parts with 20% of the contract price but has nothing to show for it, it is natural for him to request a bond. However, if we are to make and deliver, say, four items of equal value over time, we might reasonably argue that when we deliver the rst item we shall have earned 25% of the value of the advance payment. In that case, it is logical to regard only the balance of 75% of the advance as held by us against future deliveries. It therefore follows that the value of the bond should be reduced to 75% of its original value, thereby reducing our exposure and, equally importantly, reducing the fee charged by the bank. The question is: how to achievethis? Bear in mind that the bond is a document of the issuing bank. It represents an undertaking given by the issuing bank to your customer; the exporter is not party to the bond. The issuing bank has no automatic way of knowing when you have delivered equipment. Unless the customer is willing to accept a bond that automatically reduces in value on set calendar dates (which would be unlikely), the bank needs to be told when each reduction is triggered. A paragraph in the bond saying that its value shall reduce in the same proportion as the value of equipment delivered or services performed to the contract price is required. This only achieves the principle that the bond value will reduce; it is also necessary to be precise as to how the issuing bank will know the value and the proportion of deliveredgoods. Dont assume that your customer knows best in terms of documents certifying reduction mechanisms. Keep the wording simple: additional words may serve to confuse rather than adding clarity. Not all commercial lawyers will be specialists in contract bonds. The ISP98 model forms are a useful resource. Exporters recommend having a dry run with the bank including sample documents in order to ne-tune exactly the requirements, wordings, and anysignatories. Any bond reduction will only become effective after the presentation of documents that are specied in the bond. The surest way is to specify that the issuing bank will reduce the value of the bond on receipt of written advice from you supported, for example, by copies of commercial invoices (which you will have had to prepare for the customer in respect of each delivery in any case) demonstrating the value of goods delivered and copies of the bills of lading or similar. Your customer may wish to be involved in the process of reducing the value of the bond but this is to be avoided if possible. A bond reduction mechanism involving the customer is better than none but it would introduce an element of uncertainty into the process. An option, if you are to be paid from a letter of credit, is to have both the bond and the letter of credit claused to the effect that each presentation and drawing from the letter of credit reduces the value of theAPG. The best laid plans An exporter to Libya in 2010 tells of a contract involving an APG that reduced to zero on shipment. Paperwork was checked in advance by the customer. The certicate evidencing shipment was in good order, but, because of the troubles, the original bond was lost. The exporter is negotiating to be released from its obligations. A UK exporter was required to provide a 10% performance bond in support of a contract for Qatar. The bond had a reduction mechanism whereby it reduced to 5% on presentation of a completion certicate. However the issuing bank which was based in the UAE did not recognise the Qatari certicate and so the bond had to stay at 10% for the entireperiod. Chapter 6: What to watch out for and what to avoid
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vi) The bond should require the beneciary to have to state a reason for calling the bond and to give time for the exporter to rectify the alleged fault If the bond is payable on demand what good does requiring a statement of default from the customer do? Either it is an impediment on the customers freedom to get his money or, if it is not, then it is a meaningless complication of no value to either side. Well, not quite. It is the case that most bonds (by a large margin) are not called. Most of our customers, if they have a problem with our performance of the contract, speak to us rst. That is what we would hope and expect. Now, it is possible that we will simply ignore their complaints and requests for us to set matters right. That is what the bond isfor. However, what if the customer tried once, not very hard, to get us to cure his problem, we did not respond quickly enough (or perhaps we did not receive his message) and he then calls the bond? It would be valuable to us to know the reason for the call. We might, it is far from certain but we might, be able to get him to withdraw or suspend his demand while we undertake the necessary remedial work. This is one of the benets of asking for a period of notice to correct the fault, for example by requiring a demand for payment to be accompanied by a copy of a notice sent by the customer to the exporter specifying the fault complained of and giving him a period of time (perhaps a minimum of 30 days) to correctit. It is likely that your customer will be less inclined to make a frivolous demand for payment, if it has to state a reason for making the demand for payment. Clearly, an unscrupulous customer who is interested in reaching into your pockets will not be put off doing so by the need to make up an excuse but most customers do not fall into this category. It is far more common for our customers to be slightly frustrated with us than to want to rob us. The additional requirement of having to give a reason for demanding payment can be enough (in combination with the next provision, authenticated signatures) to dissuade the merely frustrated customer from, as we would see it, over-reacting. If you insure your bonds against the risk of them being called unfairly, you will need to demonstrate in your claim that the call was unfair. A statement of default that demonstrably has nothing to do with your contract will save you having to bring in an independent surveyor to say that you are not in default. Please refer to Chapter 9 for a discussion of unfair callinginsurance. URDG 758 Article 15a requires that a demand under the bond is supported by documents including a statement by the beneciary indicating in what respect the applicant is in breach of its obligations under the underlyingrelationship. If the bond is not subject to URDG758, you will need to negotiate the wording. Exporters do not always nd it easy to negotiate this provision. They recommend suggesting it is our corporate policy to have documentary evidence (your customer will most likely have used the corporate policy phrase in negotiations on a number of occasions) and it is just so that we know what we have done wrong (possibly a more appealing argument to yourcustomer). Many exporters aim to avoid the unfair calling issue altogether by making the bonds conditional, i.e. requiring the beneciary to produce documentary evidence of poor performance from an independent third party in order to call the bond. However, whilst this is undoubtedly preferable from the point of view of the exporter it may not be possible to achieve and will not be attractive to the issuing bank (which seeks certainty). Another avoidance
35
technique can be to use a surety bond, issued by an insurance company. Surety bond wordings are not always conditional, but they do have the advantages that surety/insurance companies will normally investigate the circumstances before paying out and, most importantly, they do not tie up the exporters borrowinglimit. vii) The bond should require a demand for payment to be signed by an authorised signatory (preferably two) of the beneciary and for the signature(s) to be authenticated No one but an authorised signatory should be able to call your bond. Two authorised signatories are preferable to one because the need to conspire reduces the chance of your bond being called unfairly. The authentication point is there partly as reecting a natural concern that the bond should not be called fraudulently, and partly as a method of buying you time to try to get the customer to withdraw its demand. It is possible that the demand will be signed by two authorised signatories and be accompanied by authentication of the signatures. However, authorised signatories change over time and the signatures of their replacements might not be known to the issuing bank or authenticated. The issuing bank should request such authentication before paying the demand. At the same time the bank should tell you that it has received the demand. This gives you an opportunity to speak to your customer and seek to get it to get the demand withdrawn. Unless the bond specically requires the authentication of signatures, however, remember that the issuing bank will pay without checking the authorisation of thesignatories. viii) The bond should state to which law it is subject and which courts will have jurisdiction to settle any disputes As British exporters, we would generally prefer the governing law to be English or Scottish law. Refer to Chapter 5 for a discussion of English law as it relates to on-demand bonds. However, some legal jurisdictions (e.g. Italian Law) may be more favourable in relation to the exporter in relation to bonds, but as the law of choice for international contracts tends to be English Law (for good reason: it has been well tested in the courts), it would be an unusual contract involving a different law for the associatedbonds. However, this is not the end of the story. If your bond is issued by a bank local to your, say, Indian customer it will represent a contract between an Indian bank and an Indian company which is to be performed in India. In such a scenario, a court in India would surely rule that the bond should be governed by Indian law unless a different law was specied in the contract. There may be nothing wrong with Indian law in this area, but the point is that you are likely to be more familiar with English or Scottish law than with Indian or any other law. At least, by stating in the bond that it is subject to a named system of law you are establishing a presumption that that law will apply, a presumption which would have to beoverturned. While you and your customer both have preference to your local law, it may be easier to negotiate a neutral law such as another European countrys law or New York law, whichever you are familiarwith. A similar argument arises in the choice of jurisdiction for dispute resolution. However, even if you get English law as the governing law of the bond and the English courts as the exclusive jurisdiction for dispute resolution, the problem doesnt stop there if the beneciary is not British and especially if the bond is issued by a local (to your customer) bank. An overseas beneciary could still try and resort to its local courts if it believes that it will get more favourable treatment, and in some jurisdictions this approach may besuccessful!
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The most likely defence of a bond call is fraud. If there is no clarity about choice of law, yet a need to take legal action, then because fraud is a tort, the law that will apply is likely to be the law relevant to the territory where the tort iscommitted. Many exporters advise making the bond subject to URDG 758 which says that unless otherwise stated, the law is that relevant to where the bond is issued. This reinforces that the bond is independent from the underlying contract. If you are using a standard FIDIC bond wording, it will cite URDG as the governing rules for the bond. See Chapter 10 for more onURDG. So much for what the bond should say. What should it notsay? What to avoid The bond shouldnot: ix) x) xi) be freely assignable ortransferable; top-up when called in part or in full; and allow for interest to be charged on the value of acall.
We will examine these inturn. ix) The bond should not be assignable or transferable You (or rather the bank on your behalf) give the bond to your customer in respect of your performance of your contract with your customer. If you fail to perform, it is your customer who is entitled to restitution - no one else. There should be no need for your bond to be transferred to another company or body. Not only should there be no need for it, but such a transfer contains dangers foryou. Being the other party to our contract, your customer has a natural interest in maintaining his relationship with you. It is this relationship that prevents a bond being called for no good reason. Indeed, it is this relationship that might prevent the bond being called for a very good reason. However, if your customer is able to transfer the benet of the bond to a third party, possibly one with which you have no relationship, this third party will have no interest in your company but perhaps has a need for money. Is the bond more likely or less likely to be called? It is for this reason that it is wise to have a no transfer clause in thebond. If your customer insists on the ability to assign the benet to another party, it is vital to restrict assignment to one or more named parties (e.g. the parent company of the customer, or the Ministry of Finance if the bond beneciary is a public sector entity) and to set out in the bond a clear procedure that would have to be followed before the third party could call thebond. It might also be necessary to allow transferability if the bond is being issued in connection with a contract which is being nanced by a group of lenders in that the lenders may want the bond transferred to them or their security agent (possibly also an assignment of the proceeds of the bond) as part of their security package for thenancing. Clearly, in these situations you will need to involve your lawyers. You would also need to address the situation with your unfair calling insurer, as the cover would normally be ineffective if the bond allowsassignment.
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Bank rating trap One exporter received a draft bond wording from its customer the Client containing the following clause if the issuer of such bond ceases to be rated at least A- by Standard & Poors or A3 by Moodys and the Exporter has not delivered to the Client a replacement bond which complies with the terms of the Agreement, within fourteen (14) Days after request by the Client, then the Client shall be entitled to draw on the entire outstanding amount of suchBond. The exporter deleted the clause. Of course the exporter cannot accept responsibility for monitoring the credit rating of banks. Replacement ofa bond in 14 days of the customers request may not have been practical the exporter would need more time, could not anticipate the change in rating of the bank and would not have had time to research the available capacity from anotherbank. x) It should not top-up when called in part or in full It is not unknown (but fortunately not common) for beneciaries to request a clause in the bond wording to the effect that if it is called and paid in part or in full, its value should revert to its full initial value immediately thereafter. For example, your bond has a value of 20,000; the customer demands payment of 15,000; the following day its value reverts to 20,000, the customer demands payment of 15,000, etc. There is never a good reason for this provision. You should refuse any request for such abond. xi) It should not allow for interest to be charged on the value of a call Some customers request a clause which has the effect of adding interest to the value of any call of the APG, calculated from the date of payment of the advance to the date of payment under the APG. This should be resisted for obvious reasons. If it is necessary to concede such a provision then a limit should be placed on the (otherwise open-ended) interest liability so that interest is provided for at a specied rate, but subject to wording such as: The sum payable in respect of interest shall not in any event exceed x. This gure would then be added to the principal value of the bond for the banks calculation of its exposure and itsfee. If you are in a consortium for delivering a complex project, you will need even more time to explain the structure and negotiate bondingfacilities. Return of the bond Lastly, it is important to understand that you will need to manage actively the return of the bond. After the bond expires, unless it is an SBLC, you will need to procure the physical return of the bond, otherwise the bank may simply continue to charge its fee. If the customer loses the bond, or the expiry is decades ago, you may be able to negotiate with the bank to reduce the value of your counter-indemnity to say 2 per annum. However, if the bond should suddenly reappear and be called, the bank will pay out in full, and will debit your account for the value of the call. This may seem harsh, but that is the nature of on-demandbonds.
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CHAPTER 7 EXTEND OR PAY Just before an on-demand bond expires, the beneciary can send an extend or pay (also referred to as extend or call) demand to the issuing bank. Usually this is simply a procedure employed by the beneciary to ensure that he does not lose his security as a result of your failure to arrange a legitimate extension in the validity of a bond but, as we shall see later, it is a procedure that can be open toabuse. To understand the legitimate use of extend or pay demands, put yourself in the position of yourcustomer: - you provided him with a performance bond as security against yourfailure to complete a project in accordance with the contractual provisions; the performance bond had an end-stop expiry date that was probably set a few months after the contracts scheduled completiondate; for some reason, the contract has not been completed to your customers satisfaction by the expiry date of the bond; and he has asked you to extend the bond but has not yet received conrmation from the issuing bank that the extension has beenapproved.
- -
If he does nothing and you fail to arrange for the bond to be extended, the bond will expire thus depriving him of his performance security at the very time he most needs it. In order to preserve his security, therefore, it is sensible for him to require the issuing bank either to extend the bonds validity or, if it fails to do so, to pay the value of thebond. In normal circumstances, your customers extend or pay demand might cross in the post with your extension instruction to the issuing bank, so it will have no practical effect. If, however, your extension instruction was late in reaching the issuing bank (e.g. because of communication issues), the bank would contact you to establish your intentions, and would probably accept a scanned copy of your instruction pending receipt of the original instruction. But your failure to provide an extension instruction on or before the expiry date of the bond would result in the issuing bank paying the full bond value to the beneciary and then seeking full and immediate reimbursement from you under the terms of the counter-indemnity. The lesson here is always to ensure that the issuing bank receives your signed extension instructions on letter headed paper before the expiry date of the bond. If time is tight, it is worth scanning and emailing or even faxing, if you still have the technology - an advance copy of your extension instruction to the bank at the same time as posting the original. Always remember that, if the bond was issued by a local (overseas) issuing bank, your correspondent bank in the UK will need some extra time after receipt of your extension instruction to issue its own extension instruction to the localbank. But what if an extend or pay demand is issued at a time when you dont accept that the bond should be extended? Unfortunately, the end-stop expiry date that you so painstakingly negotiated into the bond wording will not do you much good in these circumstances. You will need to negotiate a satisfactory settlement with yourcustomer.
Chapter 7: Extend or pay
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If the holder of an on-demand bond wants to keep you on the hook, it is very easy for him to require you to keep extending its validity by simply threatening to call the bond each time it approaches its expiry date. The last thing you want is for your bank to pay him the cash, so extending the validity of the bond is usually the natural response. At least extending the bond buys you some time to negotiate the release of the bond (or, perhaps, a reduction in its face value). This may mean that you have to respond to your customers demands, perhaps by nishing off the work that you were originally contracted to do, or even paying him some compensation for something he says you didnt do properly. After all, isnt this the purpose of the bond? Of course, any compensation payment should only be handed over if it can be simultaneously exchanged for thebond. Tender bond extensions: You can expect to have to extend the validity of a tender bond if you have been down-selected but before any contract is nalised (at which point your tender bond might be replaced by a performance bond). The tender bond is, after all, an instrument to prevent you pulling out before the contract is effective. However, there should not be any grounds for a customer to request an extension of a tender bond if you have been informed that your tender was unsuccessful, or that the tender process is on ice. Any such requests should beresisted. If you are condent that you have performed the contract to the letter and that your customer is acting unreasonably in sending the extend or call demand, you should not think that you can simply allow the call to proceed and then recover your money by making a claim under your unfair-calling insurance (see Chapter 9), because it is usually a condition of such insurance that you must accede to any request to extend a bond, unless the underwriter agreesotherwise. Sometimes, extend or pay demands may be made routinely by a clerk with a diary but with no knowledge of the contract. Whatever reason you might suspect lies behind the call, the demand must not be ignored and must be actedupon. So, can the beneciary keep you on the hook for ever? Well, in some ways he can, but your customer is unlikely to be that spiteful. If he was so annoyed with you or your performance, he would simply have called the bond. The fact that he is stringing you along with extend or pay demands might mean that he believes there is some chance of compromise. So, all is notlost. Try following these simplesteps: 1. If you have completed all your contractual obligations, dont wait for the bond to expire but ask for the bond to be returned as soon as your work is completed. If you have someone in territory who is helping you, ask him to obtain the return of the bond; any final payment that might be due to him could be subject to the return of thebond. If there are still some loose ends for you to finish under the contract, it is better to negotiate with your customer than to ignorehim. If you expect to be asked to extend a bond because (in your customers opinion) you have not yet completed your contractual obligations, it is often worthwhile offering to extend the bond at a reduced value. For example, if you only have to supply a couple of extra widgets, your customer might be satisfied with an extension at 5k instead of the original 100k bondvalue. Chapter 7: Extend or pay
2. 3.
40
4.
Dont be taken by surprise. If you know your customer is not satisfied and he is holding a bond that is about to expire, talk to him to find out if he is prepared to release the bond or if he will want you to extend thebond. If you receive a request to extend a bond, make sure that the issuing bank receives your extension instruction before the expiry date, if necessary by sending an advance copy by email orfax. Remember that extend or pay demands are often presented to the issuing bank just before the expiry date of a bond, leaving insufficient time for you to arrange an extension. If you have not already started the process, the issuing bank will have no choice but to pay. This is especially true of a bond issued by a bank in your customers country, because of the delay that will occur in communicating the demand to you via the UKbank. Ensure that your bank bonding line has sufficient capacity to allow you to extend an expiring bond, and that authorised signatories are available to give prompt extension instructions to the issuingbank. Dont be miserly by extending a bond by just one month. You might as well extend for three months at a time, to allow time for corrective action and/or meaningful negotiations to takeplace. If you feel that you have completed all your contractual obligations and are faced with repetitive extend or pay demands, inform your unfair-calling insurer. If you can convince your insurer that your customer is acting unreasonably, the insurer may eventually allow you to refuse to extend the bond and then treat the resulting call as unfair. But get your insurers agreement in writing before taking such a drasticstep.
5.
6.
7.
8.
9.
Chapter 7: Extend or pay
41
CHAPTER 8 YOUR BOND IS CALLED Sooner or later, despite all your efforts, one of your bonds will be called. This event is rare in capital goods exports and project nance: the threat of a bond call is more usual because it tends to result in a urry of activity to put right whatever is theproblem. In Chapter 7 we have seen the effect of an extend or pay demand and how you can react to it. What we will consider here is a simple demand for payment, rather than the extend part of extend orpay. What to do aboutit? First things rst move very quickly because the issuing bank might, if you are lucky, have informed you about the call before actually making any payment. Try to obtain from the bank a copy of the demand. This should include a written statement of default, and the reason why your customer has called your bond (but clearly only if your bond wording requires the customer to do so). If the reason is in order to comply with decree number one of the Revolutionary Command Council or similar then you have a clear indication that your customer will have no choice other than to stand by the demand and will expect the issuing bank to pay which it will. At least this will give you supporting evidence for your claim on your unfair calling insurance. It is nonetheless worth speaking to your customer to get his conrmation that your contract performance is not at fault, although of course the advent of the Revolutionary Command Council might make performance of your contract rather more challenging than you hadexpected. If the reason is clearly unrelated to your contract then again you can expect to be out of pocket and you are looking at a claim for unfair calling. Try to speak to your customer and see if you can persuade him to withdraw or at least suspend his demand for payment. You will need to act very quickly as the issuing bank (especially if local to the beneciary) will not wait long to pay out. It will not be sufcient for your customer to say to you that he is suspending or withdrawing his demand for payment this needs to be communicated by him (not by you; the issuing bank will act only on his instruction) to thebank. Political calls In 1969, the regime of King Idris was overthrown by Colonel Muammar Gadda who required that contract bonds be called, regardless of the performance of the underlyingcontracts. On 2 August 1990 Iraq invaded Kuwait and on 6 August 1990 the United Nations imposed sanctions (UN Security Council Resolution 661). The UN, after lobbying by British businesses, subsequently froze Iraqi bonds in perpetuity, thereby avoiding the risk that, once sanctions had been lifted, the bonds could have beencalled. These examples demonstrate that political risks are outside the control of the exporter, and how the extension of export credit insurance to the bond can soften the blow of the contractfrustration. Most political calls are more mundane, for example, a Government Buyer calling a bond for a reason that is unrelated to the contract that the bond isguaranteeing. In this event make a claim on your unfair calling insurance and establish, through diplomatic and legal channels, if any salvage can berealised. 42 Chapter 8: Your bond is called
If the call is clearly unfair or fraudulent, it may be worth trying to get a court injunction to prevent the bank from paying though one has to accept (especially if a local issuing bank is involved) that in most cases this is unlikely to achieve more than a brief delay in theinevitable. If the reason for the claim is related to your performance of the contract then you need to get on the telephone, send people out to see the customer and get agreement to extend the bond if necessary until the problem isresolved. Navigating a bond call An engineering company was required to provide a warranty bond, on the customers wording, to an Italian contractor for a project in Saudi Arabia. The bond did not make reference to law and jurisdiction, or to URDG758. Whereas the Saudi Arabian end-user was satised with performance, the Italian contractor required the bond to be extended, and sent through an extend or call notice. The UK exporter arranged the extension in due time before expiry, but the bond was called. The reason given for the call was that due to a delay in the contract, extra expense had been incurred by the Italian contractor, yet this was in fact because the Italian contractor had not approved drawings in a timely way, which had created knock-on effects throughout contract performance, including in relation to the Italian contractors cash-ow. The exporter became aware through other channels that the Italian contractor was late in paying a number ofsuppliers. The bond being worded without a law or rule for dealing with disputes led to the dispute being assessed under Italian Law. The end result was a negotiated settlement for repayment of the bond, with payments spread over a period that was achievable by the Italiancontractor.
Chapter 8: Your bond is called
43
CHAPTER 9 UNFAIR CALLING INSURANCE Bonds are rarely called usually the threat of a call is sufcient motivation for the exporter to put someone on a plane and resolve matters. A fair call, when the exporter has not performed according to the terms of the contract is not insurable. An unfair call where the bond is called yet the exporter is not in default of its contractual obligations is insurable, and the cover also includes calls arising as a result of a political event such as export licence cancellation, government intervention or war preventing the exporter from completing itsobligations. Unfair calling insurance is a discretionary purchase which many exporters decide to take to protect themselves against the risk of loss. Surprisingly, the bank that provides a bond on your behalf rarely requires that unfair calling insurance is purchased. This is because the insurance would only pay out after the bond was called, and the bank, in requiring to be put in funds under the terms of its counter indemnity, will be rst in, extracting the funds to which it is entitled immediately the bond is called. It is the exporter that is left with a huge negative cash ow and a write-off equal to the value of the bondcall. When a bond is called it tends to be called for the full value partial calls are rare - so the impact of bond call will be both immediate and severe. There is no prospect of making recoveries quickly since the route will be via the courts or through arbitration, and may involve an evaluation of the exporters performance under thecontract. Whichinsurer? Specialist export credit insurers provide unfair calling cover, as does UK Export Finance. Your broker will be able to advise on theoptions. What your insurance should cover There is real value in insuring unfair calling of the bond alongside cover for loss arising from non-payment or political contract frustration (e.g. force majeure) of the contract. The reason is two-fold. First, if you suffer a loss on the contract, such as licence cancellation, government intervention or buyer failure, you will naturally stop work and the buyer will have every right to call the bond. Secondly, if you encounter problems under your contract for example if payment is late the insurer covering your contract will not have to think for very long before most likely agreeing that you should carry on work. The clause in the insurance contract suggesting that you should always take the prudent route has a very different avour when there are bonds at stake. Stopping work could simply result in a bond call, and the insurer wont want to be presented with aclaim. For the insurer, there is also an advantage in covering both the contract risks and the bond risks. Premium for the contract risks covering loss arising as a result of insolvency or political events - will have been earned when the contract became effective. Bond premium, being paid on the value of bonds that are outstanding during the life of the contract, provides a continued income stream for the insurer throughout the life of thecontract.
44
Chapter 9: Unfair calling insurance
When bond unfair calling insurance decision was expensive An exporter decided to insure against non-payment and political contract frustration of a contract to supply bespoke technology, but unfair calling insurance on the associated bond seemed to be a luxury and was not takenup. The contract progressed smoothly at rst, but in due course hit a hurdle when the customer ran out of money. Losses from non-payment and workin-progress led to a credit insurance claim which was settled, less the policy excess and at the agreed indemnity. The bond was also called, but of course was not insured and therefore became a write-off. With a view to the policy condition relating to salvage, the exporter, on the advice of the insurer, took the customer to court and was successful in achieving recoveries relating to both the contract and thebond. The contract of insurance, as is usual, deemed that all amounts recovered in relation to the contract were allocated as recoveries. This meant that the recoveries nominally relating to the bond became allocated in part to theinsurer. Had the bond cover been taken up in the rst place, not only would a claim have been paid on the money lost when the bond was called, but also the allocation of recoveries would have feltfairer. There is no standard wording for unfair calling cover, but most policies cover thefollowing: unfair call where the insured (the exporter) is not indefault; fair call for political reason (licence cancellation, war, contract frustration or other force majeureevents); non-honouring of an arbitration award following a bond call (i.e. the customer fails to pay to the exporter as directed by the arbitrator, a sum which has previously been obtained by calling the bond but which has been deemed to have been an unfaircall). call arising from the exporters action in complying with the insurers instructions regarding the avoidance or minimisation of loss tender bond cover should include withdrawal of cover for thecontract. Libya: fair political call A Spanish engineering exporter designed equipment for the production line of a Libyan customer. One of the conditions for effectiveness of the contract was that the Spanish company would arrange its export licence. Another was that a down-payment of $2.5m would be made by the customer, and in return the Spanish company had to provide a $2.5m Advance Payment Guarantee. These conditions werefullled. Some months later, production was taking longer than planned, so the Spanish company applied for the export licence to be renewed. However, sentiment towards Libya had changed, and the Spanish licencing authority took a decision that the goods were capable of being re-deployed for use in the construction of Weapons of MassDestruction. The engineering equipment therefore could not be supplied. The Libyan customer called the bond. A claim was made on a Londoninsurer. Chapter 9: Unfair calling insurance
45
Standard exclusions You will usually nd that you will not be covered for loss arising from the calling of a bond resultingfrom: Material default by you, the exporter Disputes: the insurer will delay making any decision on admitting liability until any dispute is resolved (e.g. byarbitration). It will be difcult to obtain cover for bonds issued to beneciaries in certain countries, for example whose laws do not recognise expiry dates, or where the risks of doing business are veryhigh. Insolvency Insurers are careful about covering the risk of bond call where it is caused by a buyer being in nancial difculties or insolvent. There is a fear that a cash-strapped company would see the bond as a source of cash. Full cover for private sector buyers tends therefore to include a requirement that you check the creditworthiness and probity of the beneciary before the bond isissued. Bond wording While being appreciative of the pressures of negotiating export orders, insurers will expect bond wordings to be written prudently, and may ask to review the draft wording. Inparticular: The bond should in its preamble mention the contract (or tender) to which it relates. This is essential to prevent the customer changing the terms of the underlying contract after contract award, to the extent that you no longer wish to contract on those terms and thereby risk having the bondcalled. The bond should have a certain value, and clear expirydate. If it is an APG, it will be expected to include wording to allow the bond to reduce in value as deliveries takeplace. If it is an Offset Performance Bond, the insurer will want to understand the nature of the Offset obligation and the mechanism and timing for approval ofachievements. The law and arbitration provisions should be clear: in the event of a bond call if the beneciary is claiming non-performance, it may be necessary to take legal action or go to arbitration to establish if there is a valid claim on theinsurance. How the cover works Cover can be obtained either for specic bonds or for a portfolio of bonds. It is recommended that the same insurer covers the bonds and contract risks because they are naturallyinterlinked. Most policies cover bond calls arising during a given period (such as the intended expiry and bond return date). Make sure the policy allows for delays and bond extensions you do not want to be in the position of needing to extend the bond when the risk environment has deteriorated yet the insurer has been taking your valuable premium for severalyears.
46
Cover can usually be purchased with a provision to allow for extend or call or to cover time expired bonds (where you have not been released from your counter indemnity) and allow an agreed run-off or sunset period at the initial premiumrate. Should you decide to buy cover from different insurers for the contract and the associated bonds (or indeed cover the contract and not the bonds), it is worth establishing in advance that co-operation will be needed if there are payment delays or political issues and that in the event of a loss, any monies received in relation to the bond should be kept separate and not used as salvage in relation to the contract risks and viceversa. Premium Premium can be charged on the bond limit or for the bond value and expected horizon, or according to the total value of bonds outstanding at the calendar quarterdate. It is likely that if the bond is returned early, there will not be a refund of premium. That is because the insurer will have had to purchase, in advance, adequate reinsurance for the total value of the bond for the original policyperiod. Confidentiality A key condition of unfair calling covers is that the existence of the insurance is kept from the beneciary and his bank (assuming it is a local bank that is issuing the bond) in order to prevent malicious calling prompted by knowledge that the exporter is covered byinsurance. When does coverstart? While the cover purports to be for the unfair calling of the bond, the exporters loss will occur when the counter-indemnity is called by his bank and it is that loss which is insured. The bank will insist on holding the exporters counterindemnity before issuing a bond but most exporters are content to commence cover from the date that the bond itself isissued. APGs may need to be issued before the down-payment is received. If it is receipt of the down-payment (rather than receipt by your customer of the bond) that makes the contract effective, check that the insurance allows for this. The insurer needs to be made aware that you will be issuing a bond before the contract to which it relates has become effective. Clearly this has importance beyond the unfair calling insurance. It illustrates the desirability for a statement in the bond wording that the bond comes into effect only when the contract has come intoeffect. Commitment If a series of bonds is to be issued for example a 20% APG guarantee to be replaced by a 10% performance bond and, later still, a 5% retention bond then it would be wise to negotiate with the insurer that, once the rst bond had been issued (or the contract has become effective), then cover will be made available for all subsequent bonds to be issued in support of those bonds or thatcontract.
47
Tender bond cover Clearly tender bonds do not have an associated contract of sale. A typical policy will cover loss arising as a result of political events so long as the bidder (the exporter) has not failed or refused to enter into the contract for commercial reasons. It will be necessary to establish in advance of making the bid that the insurer can provide cover for the contract if you are successful. Make sure that your bond policy covers your refusal to enter into the contract if the insurer cancels the cover for thecontract. If you are submitting a non-compliant tender, check that this can be covered. You may have to conrm that you have not prejudiced your position by submitting a non-compliant tender. Wording may be included in thepolicy: Warranted that the Insured has no reason to believe that the Insureds Tender Bond may become forfeit due to any alterations, amendments and/or qualications that have been incorporated into theTender. Advice Bond unfair calling insurance is a complicated area, and the advice of an experienced insurance broker should be sought. It can make all the difference between having a policy, and having a policy that will respond to your loss. If your bonding requirements are in any way out of the ordinary, or are for particularly large sums, it is worth speaking to your broker and insurer at an earlystage.
48
CHAPTER 10 URDG URDG is the International Chamber of Commerce (ICC)s Uniform Rules for Demand Guarantees (ICC publication no 758), a set of rules that govern bonds. URDG claries that the bond/guarantee is independent of the underlying contract. It includes that, unless stated otherwise, the governing law shall be the jurisdiction of the location where the bond is issued. The purpose of URDG is to balance the interests of the various parties and to curb abuse in the calling of bonds. To a large extent this purpose is achieved where URDG isused. There is a problem, however. URDG only applies to a bond which expressly states that it shall be subject to URDG. It is therefore necessary to insert this provision in the wording of the bond. This becomes another item to be negotiated with the customer who might not want (as he might see it) to make his bond subject to rules with which he is unfamiliar and limit his absolute and unfettered ability to demand and receive payment. Of course, if URDG were more generally used the customer would be more likely to be familiar withthem. There is a similarity in the way that the banks will handle bonds and how they will handle letters of credit (ICC publication UCP 600). This is natural and, on the whole, is to be expected. Banks cannot be expected to become involved in the working of the underlying export contract and for the bond (or the letter of credit) to work as the beneciary requires everything must depend upon clear wordings and the presentation of cleardocumentation. There is a degree of exibility: URDG allows certain options. A number of provisions that are attractive to the exporter are not necessarily attractive to the beneciary. For this reason URDG is not as widely used as it might be. Historically, the previous version of URDG (URDG458) was not widely used in guarantees, unlike UCP for documentary credits, principally because it contained articles that did not reect standard guarantee practice. URDG 758, which replaced 458 in 2007, is more detailed than its predecessor, and aims to be clear, precise, balanced and more comprehensive than URDG458. URDG 758 article 25c concerns automatic termination after three years if the bond does not contain an expiry date or event. Despite this looking to be an improvement, in practice, itis of limited benet. It is rare for a bond to be silent on this aspect. Even a clause stating that the bond is valid until the beneciary releases the guarantor could be interpreted as containing an expiry event. Furthermore, it would be expected that the governing law will take precedence over URDG, and some foreign laws/civil codes dictate that guarantees have to be returned to permit release, or that the beneciary can submit a demand after the stated expirydate. URDG can only apply if agreed by both parties and expressly stated within the guarantee and counter-guarantee - its rules and articles are not automatically imposed. Even if the banks involved in issuing the bond are using SWIFT, the secure bank system for passing messages, payment instructions etc, there will need to be an instruction as to whether the bond will be subject toURDG.
Chapter 10: URDG
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APPENDIX 1 SOME SAMPLE WORDINGS Please regard these wordings as examples only. They have all been used but will not necessarily be appropriate for the circumstances of any particular contract. It is important that you contact your bank early if you believe that your customer will require you to procure the issue of bonds, and have the draft wordings looked over by yourlawyer. Tender bond (ondemand) [On letterhead of [UK incorporated bank] [LondonOfce]] To: [Beneciary] Ref: [ ] In consideration of your having permitted our customer, [exporter] (the Company) to [tender/bid] for the supply of [], we hereby undertake that we shall pay to you, on receiving at our address printed above/below, your rst written demand signed by two duly authorised signatories duly authenticated by your bankers, complying with the requirements hereof, quoting the above reference number and stating the amount payable and that the Company has either withdrawn their bid on or before [] or been called upon to enter into a Contract in accordance with the terms of their [tender/bid] and has failed to enter into such a Contract, the amount stated in thatdemand. PROVIDED ALWAYSthat: 1. 2. 3. 4. 5. This undertaking shall not take effect until the Company has confirmed to us in writing that they have submitted their [tender/bid]. This undertaking shall expire on [ ]. This undertaking shall become null and void upon itsexpiration. Our liability under this undertaking shall not exceed in aggregate [ ] ([ ] PoundsSterling). This undertaking is addressed only to you and may not be assigned ortransferred. This undertaking shall be returned to us upon its expiration, or as soon as our liability has been discharged, but a failure to return this undertaking shall not affect its expiration or ourdischarge. This undertaking shall be governed by and construed in accordance with English law. Any dispute concerning this undertaking shall be settled in the Englishcourts. A person who is not a party to or a named addressee under this undertaking shall have no right under the Contracts (Rights of Third Parties) Act 1999 to enforce any terms of thisundertaking. Dated this .. day of For and on behalf of [UK incorporated bank] [LondonOfce]
6.
7.
50
Appendix 1: Some sample wordings
Advance Payment Guarantee (ondemand) On letterhead of [UK incorporated bank] [LondonOfce] To: [Beneciary] Ref: [ ] In consideration of your making an Advance Payment of [] ([] Pounds Sterling]) representing []% of the total contract price to our customer, [Exporter] (the Company) in accordance with the terms of contract dated [] between you and the Company for the supply of [] (the Contract), we hereby undertake to repay to you, on receiving at our address printed above your rst written demand signed by two duly authorised signatories duly authenticated by your bankers, complying with the requirements hereof, quoting the above reference number and stating the amount payable and that the Company has failed to repay the said Advance Payment and has failed to perform the terms of the Contract, the amount stated in thatdemand. PROVIDED ALWAYSthat: 1. This undertaking shall not take effect until the Company has confirmed to us in writing that the Contract has become fully effective in accordance with its terms and that the Advance Payment has been received by the Company fromyou. This undertaking shall expire when its value has been reduced to nil in accordance with clause 3 below [or upon presentation to us of a copy of a Final Acceptance Certificate issued in accordance with Clause [ ] of the Contract] or on [ ], whichever is the sooner. This undertaking shall become null and void upon itsexpiration. Our liability under this undertaking shall not exceed in aggregate [ ] ([ ] Pounds Sterling) and shall be automatically reduced by [ ]% of the contract price of [each delivery/services performed] under the Contract and the production to us by the Company of a copy of a signed Certificate of Acceptance shall be conclusive evidence of this for thispurpose. No claim shall be made under this undertaking before the scheduled date for the first delivery under the Contract or after the scheduled expiration of thisundertaking. This undertaking is addressed only to you and may not be assigned ortransferred. This undertaking shall be returned to us upon its expiration, or as soon as our liability has been discharged, but a failure to return this undertaking shall not affect its expiration or ourdischarge. This undertaking shall be governed by and construed in accordance with English law. Any dispute concerning this undertaking shall be settled in the Englishcourts. A person who is not a party to or a named addressee under this undertaking shall have no right under the Contracts (Rights of Third Parties) Act 1999 to enforce any terms of thisundertaking.
2.
3.
4.
5. 6.
7.
8.
Dated this .. day of For and on behalf of [UK incorporated bank] [LondonOfce] . Appendix 1: Some sample wordings 51
Performance bond (ondemand) [On letterhead of [UK incorporated bank] [LondonOfce] To: [Beneciary] Ref: [ ] In consideration of your having entered into a contract dated [] (the Contract) with our customer, [exporter] (the Company) for the supply of [], we hereby undertake that we shall pay to you, on receiving at our address printed above your rst written demand signed by two duly authorised signatories duly authenticated by your bankers, complying with the requirements hereof, quoting the above reference number and stating the amount payable and that the Company has failed to perform the terms of the Contract, the amount stated in thatdemand. PROVIDED ALWAYSthat: 1. This undertaking shall not take effect until the Company has confirmed to us in writing that the Contract has become fully effective in accordance with itsterms. This undertaking shall expire when its value has been reduced to nil in accordance with clause 3 below [or upon presentation to us of a copy of a Final Acceptance Certificate issued in accordance with Clause [ ] of the Contract] or on [ ], whichever is the sooner. This undertaking shall become null and void upon itsexpiration. Our liability under this undertaking shall not exceed in aggregate [ ] ([ ] Pounds Sterling) and shall be automatically reduced by [ ]% of the contract price of [each delivery/services performed] under the Contract and the production to us by the Company of a copy of a signed Certificate of Acceptance shall be conclusive evidence of this for thispurpose. No claim shall be made under this undertaking before the scheduled date for the first delivery under the Contract or after the scheduled expiration of thisundertaking. This undertaking is addressed only to you and may not be assigned ortransferred. This undertaking shall be returned to us upon its expiration, or as soon as our liability has been discharged, but a failure to return this undertaking shall not affect its expiration or ourdischarge. This undertaking shall be governed by and construed in accordance with English law. Any dispute concerning this undertaking shall be settled in the Englishcourts. A person who is not a party to or a named addressee under this undertaking shall have no right under the Contracts (Rights of Third Parties) Act 1999 to enforce any terms of thisundertaking.
2.
3.
4.
5. 6.
7.
8.
Dated this .. day of For and on behalf of [UK incorporated bank] [LondonOfce]
52
Appendix 1: Some sample wordings
APPENDIX 2 LOCAL LAWS AND CUSTOMS Exporters experiences of individual countries are listed below but it is very important that local advice is sought each time a bond is issued. Local laws and customs will change overtime. ALGERIA Bonds may only be issued by local banks. The Algerian Ministry of Finance stipulates the format of the counter-indemnity. Expiry dates are mandatory (Central Bank = Banque dAlgerieregulations): the expiry date of a performance bond is restricted to six months after the contractual date for completion of the underlying (performance) obligations, and the bonds expiry date is the latest date for receipt ofdemands. BANGLADESH Beneciaries tend to require their own bond wordings although persistence in negotiating this point has sometimes succeeded. These wordingstypically: require a period after a bonds stated expiry date for receipt of demands, and include a clause making the bond extendible at the beneciarysrequest. BELARUS CHINA Belarus has adopted the UN Convention (see Appendix3) Customers may ask for the law of the Peoples Republic of China and arbitration in Beijing or in a city appropriate for where the work is being done. French Law has been found to be acceptable. URDG is generally acceptable4, and Chinese customers respect bond expirydates. Certain contracts are understood to require high levels ofbonding. Ecuador has adopted the UN Convention (seeAppendix3). Egyptian law and practice deems bonds that require the beneciary to produce documentation in support of a demand (other than the beneciarys own certicate/ statement of default) are notacceptable. El Salvador has (seeAppendix3). adopted the UN Convention
COLOMBIA ECUADOR EGYPT
EL SALVADOR FINLAND GABON
Finnish Law disallows URDG758. Gabon has adopted the UN Convention (see Appendix3).
Anhui Import & Export Co (China) v Oswal Chemicals & Fertilizer Ltd (India) 2007
Appendix 2: Local laws and customs
53
INDIA
Bonds issued by Indian banks are commonly given on ofcial stamped paper, thereby incurring a nominal stamp charge to be paid by the exporter (stamp duty can vary quite considerablybetweendifferent cities/regions ofIndia). Indian banks tend to claim commission for the whole period of the bond at the time of issue, including a small fee for cancelling a bond. Bonds in favour of Government/Public Authorities attract an additional six monthscommission. The Reserve Bank of India requires that sizeable advance payments should be guaranteed by a bond from a reputed bank situated outsideIndia. Many Indian beneciaries require a period of between three and 24 months after a bonds stated expiry date for receipt of demands (although the reason for the demand must have occurred within the bonds validity). Government beneciaries may have an automatic period of up to 30 years in which to make a demand or initiate legal proceedings in respect of an event that occurred within the bondsvalidity.
INDONESIA
It is usual for beneciaries to require that bonds are issued by localbanks. Local banks are often required to make reference to Chapter 1832 of the Indonesian Civil Code in their bonds, which has the effect of making the bonds payable on rst demand regardless of any conditions in the wording of thebond. Under Indonesian law the beneciary has a period of 14days beyond the bonds stated expiry date in which to submit ademand.
IRAN
All bonds in favour of Iranian beneciaries must be issued by a local bank (unless the beneciary is itself a bank). Bonds usually include a clause to the effect that they are extendible at the request of the beneciary. If the exporter is not willing to extend the bond, the bank has an obligation to make payment without the need for any further demand from thebeneciary.
54
ITALY
Banks can be injuncted from paying on a demand that is fraudulent. The denition of what is fraudulent can be fairly wide; examples include A request made by a person who had illegitimately introduced himself as agent of thebeneciary. The beneciary presents as a demand for payment a document which is different from the one specied in thebond. There is documentary evidence that the beneciary has previously agreed that the exporter has fully performed thecontract. There is documentary evidence that the beneciary has previously alleged in court that the export contract is null andvoid. The demand for payment is made after the expiry date of thebond.
JORDAN
Generally only a bond issued by a local bank is acceptable. It is a common practice of Jordanian beneciaries, on receipt of a bond or any extension of it, to lodge a provisional claim for payment of the bond on expiry. This is done largely as a precaution against the beneciary forgetting to submit a demand within the validity period of the bond and/or to request an extension of the bond before its expiry date. It is possible that the local bank will take the view that a provisional claim creates an immediate obligation to pay on expiry unless the beneciary has previously returned the bond forcancellation. In 1983 the Supreme Court of Jordan ruled that bonds become automatically due for payment at their expiry date if not returned to the issuer. This is thought only to apply to bonds given to governmentbeneciaries.
KUWAIT LIBERIA MALAYSIA
Kuwait has adopted the UN Convention (seeAppendix3). Liberia has adopted the UN Convention (seeAppendix3) Contract bonds must always contain an expiry date. If the expiry date is not expressed as a nal date for receipt of demands, the bond is automatically valid for demands made up to six years after the expiry date, unless it is returned for cancellation. A suggested expiry clauseis: Notwithstanding anything herein contained, this undertaking shall expire on (the Expiry Date). All claims hereunder must be received by us on or before the Expiry Date [or some later specied date], failing which this undertaking shall be terminated and be null and void and of no further effectwhatsoever. Under Malaysian exchange control regulations, bonds (and possibly counter-indemnities) issued by foreign banks in favour of Malaysian beneciaries must not be denominated inMYR. Appendix 2: Local laws and customs 55
MEXICO MOROCCO
Mexican beneciaries will often accept standby letters of credit in place of bankbonds. It is usual for beneciaries to require that bonds are issued by localbanks. Where the beneciary is a government body, expiry dates have no effect and liability therefore continues until the bond is returned andcancelled. A private sector beneciary must either lodge a demand or institute legal proceedings by the expiry date of the bond for the claim to be considered valid. He then has up to six years in which to pursue thematter.
PAKISTAN
Whilst in the majority of cases a local bank guarantee is required, bonds in a prescribed text which are issued by foreign banks are sometimesaccepted. All bonds must contain a xed expiry date. Under Pakistani law, however, the beneciary has a period of three years beyond the bonds stated expiry date in which to submit a demand or up to 60 (sixty) years in the case of government bodies and semi-government agencies provided the reason for the demand occurred on or before the expiry date of the bond. Thus, any bond governed by Pakistani law cannot be considered terminated until it has been physically released by thebeneciary. Despite the above, it is a common practice of Pakistani banks to insert a limitation clause in their bonds, e.g. Notwithstanding anything mentioned hereinbefore, our liability is restricted to ............. and shall not extend beyond ............... All claims under this undertaking must be presented to .............. on or before .............. Unless claims are so presented, all rights and benets under this undertaking shall be forfeited and .............. shall be released of all claims demands or liabilities of any kind or characterwhatsoever.
PANAMA
Panama has adopted the UN Convention (see Appendix 3). All bonds issued by banks in Panama are subject to that Convention unless expresslyexcluded. The Central Bank of the Philippines prohibits local commercial banks from issuing bonds. Some banks may be willing to issue standby letters of credit but, under Philippine banking law, they are required to register with the Central Bank all requests to issue standby letters of credit with a period exceeding oneyear. Many of the bonds issued by Saudi Arabian banks are extendible at the beneciarys request, which often leads to extend or pay demands. Government beneciaries normally expect Saudi Arabian Monetary Authority text to apply tobonds.
PHILIPPINES
SAUDI ARABIA
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SRI LANKA
Whilst in the majority of cases a local bank bond is required, bonds in a prescribed text which are issued by foreign banks are sometimesaccepted. Where the beneciary is a government body, expiry dates have no effect and liability therefore continues until the bond is returned andcancelled. A private sector beneciary must either lodge a demand or institute legal proceedings by the expiry date of the bond for the claim to be considered valid. He then has up to six years in which to pursue thematter.
SYRIA
Bonds must normally be issued by the Commercial Bank of Syria, using an ofcial text and subject to Syrian law. The bond wording refers to the date of temporary receipt in the contract, this being when the buyer intends taking over the goods on a provisional basis. There is no limitation on the period after expiry for the receipt of demands (although the reason for the demand must have occurred within the bonds validity). Stamp duty is levied not only on issue of a bond but also on each amendment. A series of extensions to a bond should therefore be avoided ifpossible. There is no certainty that expiry dates have any value. Under Thai law, a guarantee cannot be considered released/cancelled until such time as the original guarantee is returned to the guarantor, or the guarantor is formally released by the beneciary Tunisia has adopted the UN Convention (see Appendix3). Standby letters of credit tend to be the norm. Where bonds are issued, a local bank issuer bond is usually required; but foreign banks can be accepted. Bonds issued in favour of public authorities often do not have a xed expirydate. For bonds issued by a Turkish bank in favour of a Turkish beneciary, it is a legal requirement that the bond be for a principal amount plus legal interest. This can result in an open-ended liability. In most cases, interest on advance payment guarantees is stated to be payable from the date the advance payment is made until the date it is repaid. In the case of other types of bond, interest only accrues from the date a demand is made until the date ofsettlement. Upon issue of a bond and on each amendment, stamp duty is charged at around 0.6% of both the bond value and the UK banks counter-indemnity. Since the bond is also subject to local tax, this can produce an effective total scal duty and taxes rate of over 1.2% which the exporter will have topay.
THAILAND
TUNISIA TURKEY
57
UAE
Where a bond contains a xed expiry date and is subject to UAE law, it may be cancelled immediately following its expiry, irrespective of the return of the document for cancellation. It is common practice for the issuing bank to contact the exporter (or UK bank) after expiry to ascertain whether the bond is to be extended. If it is not to be extended, the bank takes steps to secure the return of the original bond document from the beneciary and cancel the liability upon itsreturn. Bonds containing a non-assignability clause are generally not acceptable to government beneciaries Ex parte applications for freezing orders can be brought before the local courts pursuant to Article 417 of the Commercial Transactions Code to prevent the cashing in of APGs and Performance bonds. Application for precautionary attachment orders can be instituted to safeguard the amount of the guarantee in the event of a legitimate fear that it may be lost and where a substantive dispute is to be led before the courts within eight days of the date oforder.
USA
Standby letters of credit and surety bonds tend to be the norm in the USA. In some cases, the required value of a surety bond can be 100% or more of the contractprice. The USA has signed but not ratied the UN Convention (see Appendix3).
VENEZUELA
Certain contracts are understood to require high levels ofbonding.
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APPENDIX 3 THE UN CONVENTION The UN Convention on Independent Guarantees and Standby Letters of Credit (the UN Convention) was adopted by the UN General Assembly in December 1995 and came into force in January2000. It was drafted by UNCITRAL, which is an intergovernmental body of the UN General Assembly that prepares international commercial law instruments designed to assist the international community in modernising and harmonising laws dealing with international trade. The working group which prepared the draft UN Convention consisted of representatives of several countries including, in the case of the UK, representatives of what is now the Department of Business Innovation and Skills and the British Bankers Association (BBA). The UN Convention is intended to provide a harmonised set of rules for the two types of instrument referred to in its full title and to provide greater legal certainty in their use for day-to-day commercial transactions. Although the phrase Independent Guarantees is used in its title, this includes ondemand bonds, on-demand contract bonds, simple demand and other expressions, thus illustrating the lack of agreement at present even on the title to be given to these bonds/guarantees. In addition to being consistent with and working in tandem with URDG, the UN Convention supplements deals with issues beyond the scope of these rules, in particular regarding the question of fraudulent or abusive demands for payment and judicial remedies in such instances. ISP98 was designed to be compatible with the UN Convention. There is a major difference in emphasis; only a Government can adopt the UN Convention for its country. The ICC rules will apply only if expressly stated in the guarantee or standby letter of credit, whereas the UN Convention automatically applies to such documents issued from a country which has adopted the UN Convention unless expressly excluded from thedocument. Although the UN Convention was endorsed by the ICC, only about half a dozen countries5 have adopted it so far; the USA has signed it but not ratied it yet. The UK has not established the level of interest or potential benets of adopting the Convention. It often takes time for countries to get round to acceding to and ratifying conventions - though sometimes the delay may result in the subject being shelved. It may be that the various parties involved in international trade nd the voluntary sets of relevantinternational rules such as ISP and UCP are adequate for theirneeds. The merits and drawbacks of the Convention, from the point of view of the British exporter, can be summarised asfollows: Merits Application of the Convention is automatic (unless excluded see below) when the issuer of the bond is in a country that has ratied the Convention. There is no need for specic reference to the Convention in the bondwording. T ransfer: The right to demand payment cannot be freely transferred (although proceeds can be assigned unless otherwisestipulated).
http://www.uncitral.org/uncitral/en/uncitral_texts/payments/1995Convention_ guarantees_status.html
Appendix 3: The UN Convention
59
E xpiry: Local law cannot override a specied expiry date or event. Where not specied, the bond expires six years from issuance. Retention of the document does not, of itself, allow demands afterexpiry. D eemed good faith: The beneciary, when demanding payment, is deemed to certify that the demand is not in bad faith. An explanatory note makes clear that this is an obligation, not an assumption (the beneciary implicitly certies ). The exporter has a right of action if there is strong evidence that this certication is untrue (see below) or if the guarantee is being used for a criminalpurpose. T ime to pay: The guarantor has up to seven business days from receipt of the demand (unless otherwise stipulated) within which to decide whether or not to pay. This allows some time for legal or other action byexporter. C onicts of law: The applicable law is specied by the Convention, if not clear from the guarantee, as that of the country where the guarantee wasissued. Drawbacks
N ot compulsory: Guarantee wordings may exclude the application of theConvention. R ight of non-payment: Guarantors may withhold payment only if it is manifest and clear that a document is not genuine, the demand is not supported by the guarantee or the demand has no conceivable basis (per examples given). Reasonable belief is not sufcient cause. However, exporters can apply for a provisional injunction (a) if immediately available strong evidence shows a high probability that one of the foregoing circumstances exists or (b) on the basis that the guarantee is being used for a criminalpurpose.
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Appendix 3: The UN Convention
APPENDIX 4 TERMINOLOGY APG Beneciary Bid bond Contract bond Advance payment guarantee: bond securing an advance or mobilization payment of the samevalue. The recipient of thebond. Also known as a tender bond, guarantees abid. Bond supporting a contract. Includes APGs, performance bonds, warranty bonds, retention bonds (but not bidbonds) An accepted bill of exchange, such as may be necessary for a beneciary to call a Standby Letter of Credit (SBLC) The UKs Export Credit Agency now trades as UK Export Finance (qv). Fdration Internationale Des Ingnieurs-Conseils, the International Federation of Consulting Engineers, publishes standard wordings forcontracts. International Chamber of Commerce. The ICCs aim is to make it easier for companies in different countries to trade with each other, thus contributing to the expansion of internationaltrade. The Institute of International Banking Law and Practice holds model standby forms on its website for free use. These include a model reductionmechanism. The ICCs set of rules dening delivery and transfer ofrisk. International Standard Banking Practice for the examination of documents under documentary credits. This complementsUCP600. ICC International Standby Practices 1998 - the Institute of International Banking Law & Practice set of rules applied by some banks to stand-by letters of credit and include the rights and obligations of the variousparties. Compensation agreed in the contract, including dened reasons andvalues. A Material Adverse Change (MAC) clause may be included in a banks counter-indemnity. See Chapter3. Guarantees exporters performance in relation to an offset requirement relating to an exportcontract. Standby Letter of Credit The Society for Worldwide Telecommunication Appendix 4: Terminology Interbank Financial
Draft ECGD FIDIC
ICC
IIBLP
Incoterms 2010 ISBP 2013
ISP98
Liquidated Damages MAC clause Offset performance bond SBLC SWIFT
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UCP600
ICC Uniform Customs and Practice for Documentary Credits For more information on UCP600 and letters of credit, please refer to the BExA Guide to letters of credit, published in2007.
UK Export Finance
UK Export Finance is the trading name for the Export Credits Guarantee Department (ECGD), the UKs ofcial Export Credit Agency. UK Export Finance can provide Bond Support to ease the issue of bonds supporting export contracts where the exporter is carrying on business in the UK and there is a minimum 20% UK content. Unfair calling insurance can be provided for bonds issued in relation to contracts that UK Export Finance is supporting (e.g. by buyer creditnancing) ICC Uniform Rules for Demand Guarantees. See Chapter 10. URDG758 superseded URDG 458 on 1st July2007.
URDG 758
62
Appendix 4: Terminology
Aon UK Limited 8 Devonshire Square London EC2M 4PL Tel: +44 (0) 207 623 5500 Email: atc@aon.co.uk www.aon.co.uk
Contact: Robert Michael Head of Business Development Tel: +44 (0) 207 086 0330 Email: robert.michael@aon.co.uk
Aons 65,000 employees in over 500 ofces across 120 countries service clients requirements at a global level whilst responding to their specialist needs in individual markets. Aon posted 2012 revenues of $11.5 billion dollars. Aons core value is client focus. By recognising that each client has unique business needs, Aon has developed expertise across a complete range of business processes, products and industries. Account relationship managers form a comprehensive perspective of each clients organization, matching Aon products and services to the clients business strategy. Aons specialist Trade Credit team works with you to design specic solutions to protect your export contracts from commercial and political risks, and enable you to nance your sales. Aons bonding services include the provision of: Unfair calling insurance Surety bonding Travel bonds Specialist guarantees
Aons Trade Credit, Political Risk, Bonding and Cargo teams have been supporting British exporters for many years.
Sponsors literature
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ABC International Bank plc 1-5 Moorgate London EC2R 6AB Tel: +44(0)20 7776 4000 www.arabbanking.com/world/abcib
Contact: David Beeley Global Trade Finance Group Tel: +44(0)20 7776 4107 Email: david.beeley@arabbanking.com
Financing trade between Europe and the Arab world is a specialised business. Your bankers need genuine hands-on experience and in-depth local knowledge. No institution is better placed to support your trade and business links with the Middle East and North Africa (MENA) region than ABC International Bank plc (ABCIB). ABCIB is incorporated in the UK and headquartered in London, with operations throughout the EU - including Paris, Milan, Frankfurt and Stockholm - as well as offices in Istanbul and Moscow. As a wholly-owned subsidiary of Arab Banking Corporation a premier regional bank in the Arab world, headquartered in the Kingdom of Bahrain - ABCIB benefits from its parents financial strength and wide regional and global presence both in the MENAregion including Algeria, Libya, Tunisia, Egypt, Lebanon, Jordan, Iraq and the UAE - and beyond, through its operations in New York, Singapore and Sao Paolo. ABCIB itself has a strong focus on international trade, providing innovative and tailored solutions to meet clients trade nancing needs, from traditional documentary credits, guarantees and ECA facilities through a range of more structured products such as receivables financing, forfaiting and cutting-edge Islamic offerings. Project nance advisory services, treasury operations and shariah compliant products and structures fully complement and support ABCIBs core trade nance activities.
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Sponsors literature
BNP Paribas UK Branch 10 Harewood Avenue London, NW1 6AA Tel : +44 207 595 2000 http://cib.bnpparibas.com
Contacts David Wheeler: +44 203 296 8839 Amanda Hunter: +44 207 595 4180
BNP Paribas Corporate and Investment Banking (CIB) is a leading provider of solutions to a wide range of clients including corporates, sovereigns, nancial institutions and investors worldwide. Approximately 19,000 professionals in 45 countries provide clients with personalised services for managing their risks and assets, nancing and expanding their business and servicing their operational needs. BNP Paribas CIB excels in: Corporate Banking - where it has leading franchises in Transaction Banking (trade finance, cash management) and in Specialised Financing (energy & commodities, transportation, export, project, leveraged, media telecom, corporate acquisition nance and real estate) Derivatives - where it is one of the leading global players in interest rates, credit, foreign exchange, commodity and equity derivatives. Advisory and Capital Markets - where it is a top European house in ECM and a global leader in DCM (bond, convertibles and equity issuance) BNP Paribas was named Bank of the Year 2012 by the International Financing Review. BNP Paribas trade nance franchise is recognised as one of the worlds top3, involving over 250 trade nance experts located in more than 100 dedicated Trade Centres across 60 countries. BNP Paribas solutions enable its clients to optimise, secure and nance international trade transactions worldwide. In addition to a complete range of traditional trade products and services, BNP Paribas offers structured trade and customised supply chain management solutions as well as state-oftheart web based platforms.
Sponsors literature
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Ducroire | Delcredere S.A. N.V. Credit insurance Floor 28 30 St Mary Axe London EC3A 8BF Tel: +44 (0) 20 7469 4166 Fax: +44 (0) 20 7469 4001 www.ducroiredelcredere.co.uk
Contact: Andrew Strong UK Director Email: a.strong@ducroiredelcredere.co.uk Tel: +44 (0) 20 7469 4168
At Ducroire | Delcredere our mission is to cover our clients against the shortterm payment risks attached to domestic and international business and thus support economic growth and the nancing of global trade. Our aim is to do this by providing a bespoke service, adapted to the needs and the distinctive business strategy of each client, large or small. Ducroire | Delcredere S.A. N.V. provides insurance cover against the political and commercial risks attached to trade. We seek to cater for the needs of British exporters, delivering the risk protection that will allow them to do business with condence both at home and in markets around the world. Ducroire | Delcredere has the expertise and risk appetite to strongly support trade with a wide range of developing and emerging economies. We have a deep-rooted understanding of local conditions in countries on all continents, and the political and economic factors that affect the functioning of trade and levels of payment risk. We closely monitor the business climate, sector by sector, and the performance of individual companies. This knowledge enables us to measure the risks our clients face, so that we can adapt our service and levels of cover to support them effectively. Never take emerging markets at face value: always check at www.ducroiredelcredere.co.uk, where our view on all the markets of the world is shown.
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Sponsors literature
Emirates NBD PJSC, London branch 2 Basil Street London SW3 1AA Tel: +44 (0) 20 7838 2222 Fax: +44 (0) 20 7581 0575 www.emiratesnbd.co.uk
Contact Carlo De Vos Head of Wholesale Banking Tel: +44 (0) 20 7838 2279 Fax: +44 (0) 20 7581 0575
Rated A+ (Fitch), Emirates NBD is the largest bank in the UAE and one of the key nancial institutions in the Middle East with a presence in Saudi Arabia, Egypt, Qatar, Singapore, China and the UK. Its mission is to be the leading and most dynamic nancial services provider in the Middle East through an expanding network of subsidiaries and branches, complemented by a wide array of banking relationships across Europe and South-East Asia. As part of this mission, the London branch aims to support UK and European corporates and nancial institutions in sustaining and developing relationships with the UAE, GCC and the wider MENA region through a variety of products, including corporate and investment banking and trade nance related servicessuch as: - issuance of guarantees - confirmation and discounting of letters of credit - discounting of receivables - treasury related services (F/X, Interest rate swaps)
Sponsors literature
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Euler Hermes UK Contact: 1 Canada Square Matthew Wells London Head of New Business E145DX Tel: + 44 (0) 20 7510 8017 Tel: +44 (0) 20 7512 9333 Email:matthew.wells@eulerhermes.com Email: enquiries@eulerhermes.com Visit: www.eulerhermes.co.uk Euler Hermes, part of Allianz, is the world's leading credit insurer, protecting thousands of businesses across the UK from the threat of unexpected customer insolvency. With more than 6,000 staff and a presence in more than 50 countries, the Euler Hermes group insures more than 700 billion business transactions worldwide. Euler Hermes is the UK's largest credit insurer with a dedicated export underwriting team for all sectors, insuring clients deliveries to customers in the UK and overseas. We are committed to the export market and will continue to work closely with our customers and BExA to support the industry going forward. With over 95 years of experience we insure over 60 billion of trade transactions each year for companies of all sizes from SMEs to multinationals. We cover not only domestic trade, but also export, helping businesses to identify the right trading partners and monitor the nancial health of their clients around the world. A particular strength of Euler Hermes, beyond the condence given by our AA-Standard & Poor's rating, is how we manage risk. We hold information on more than 40 million companies worldwide, which is regularly updated through a network of more than 1,500 Risk Analysts embedded within the local business community worldwide. This commitment to obtaining the most up-to-date financial information is at the heart of helping businesses make better informed credit risk decisions whatever the sector and wherever in the world they wish to trade. Our service extends beyond credit insurance to embrace a range of credit management solutions, including bonding, surety and debt collections, making maximum use of our local contacts, knowledge and expertise.
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Sponsors literature
GIB London Branch One Knightsbridge London SW1X 7XS Tel 020 7393 0410 www.gibonline.com
Contact Mr Charbel Khazen SVP & London Branch Manager charbel.khazen@gibuk.com Tel 020 7393 0442
Gulf International Bank (GIB) aims to be the international GCC bank with regional expertise, global outreach and innovative nancial solutions; and to be a value-adding partner, leveraging cutting-edge technology and superior human capital. GIBs mission is to provide innovative, convenient and customised financial products and services and, in parallel, to build and retain a reputation for trust, quality and reliability in order to establish GIB as the partner of choice and create long-term relationships. This will enable the Bank to add value for its customers, be an employer of choice and meet shareholders objectives. The Bank was established in the Kingdom of Bahrain in 1975, and it is licensed by the Central Bank of Bahrain as a conventional wholesale bank. It is owned by the six GCC governments, with the Public Investment Fund of Saudi Arabia holding a majority stake (97 .2 per cent). GIB has branches in London, New York, Riyadh and Jeddah, and representative ofces in Beirut and Abu Dhabi, in addition to its main subsidiaries, Gulf International Bank (UK) Limited, and Riyadh-based GIB Capital. GIB out of its London Branch can support European based companies, which have a trade activity in the Gulf Cooperation Council (GCC) through the conrmation of documentary credits issued by banks in the region in their favour, the discounting of trade receivables, the issuing of letters of credit or contract guarantees in support of their projects in the GCC or handling their treasury requirements by way of offering foreign exchange services, hedging instruments of other related solutions.
Sponsors literature
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National Bank of Abu Dhabi One Knightsbridge London SW1X 7LY Tel: +44 (0)20 7393 3600 Fax: +44 (0)20 7235 4712 www.nbad.com
Contacts: Jeff Fallon Head of Trade Finance-Europe Tel: +44 (0)20 7393 3615 Fax: +44 (0)20 7235 4712 Email: jeff.fallon@nbad.com Richard Collens Head of Corporate Banking-Europe Tel: +44 (0)20 7393 3611 Fax: +44 (0)20 7235 4712 Email: Richard.collens@nbad.com
The National Bank of Abu Dhabi (NBAD), The Number One Bank in UAE, was incorporated in 1968 and is listed on the Abu Dhabi Securities Exchange (ADX). Ranked as one of the top 50 safest banks in the world since 2009, NBAD currently operates across 19 countries on ve continents. NBADs overseas network stretches from China and Hong Kong in the Far East to Malaysia in the South East; Oman, UAE, Kuwait, and Bahrain in the G.C.C.; Jordan and Lebanon in the Levant; Egypt, Sudan, South Sudan and Libya in Africa; France, Switzerland, Channel Islands, and UK in Europe; Brazil in South America, and the USA in North America. NBAD has a strategy to expand to 41 countries by 2022. NBAD provides its customers with a wide variety of nancial services targeting all segments of the consumer and corporate markets. The global trade nance business of NBAD offers a wide range of solutions to clients trade nance requirements, including documentary credits, contract bonding, forfaiting and receivables nancing. Trade Finance activities are complemented by NBADs other product groups which include corporate banking, investment banking, global project and structured nance, leasing and Islamic banking. NBAD is rated senior long term/short term A+/A-1 by Standard & Poor's (S&P), Aa3/P1 by Moodys, AA-/F1+ by Fitch, A+ by Rating and Investment Information Inc (R&I) Japan, and AAA by RAM (Malaysia) , giving it one of the strongest combined rating of any Middle Eastern nancial institution.
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Sponsors literature
Qatar National Bank QNB London Branch 51 Grosvenor Street London W1K 3HH www.qnb.com.qa
Contact: Neil Reid, Manager Trade Finance Email: Neil.Reid@qnb.com.qa Tel : 0207 647 2617
Through our network which reaches from Qatar across 25 countries, QNB Group is ideally placed to capture export trade flows from Europe to the MENA region. By offering Conrmation and Discounting of Letters of Credit and the issuance of Bonds and Guarantees in support of MENA projects and contracts, taking advantage of all-in pricing where available within our network, QNB acts as a valuable MENA partner. Bloomberg Markets, the leading provider of Business, Financial and Economic news has ranked QNB as the Worlds Strongest Bank in its 2012 ranking. The 78 banks in Bloombergs ranking list included some of the largest and most renowned nancial institutions in the world, with QNB being the only bank from the MENA Region. Based on the Groups continuous strong performance and the expanding international presence, the bank is currently ranked as the most valuable brand in the MENA region, with a current world ranking of 120 in 2013.
Sponsors literature
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UK Export Finance (Operating name of the Export Credits Guarantee Department) 1 Horse Guards Road, London SW1A 2HQ Switchboard: 020 7271 8000 Fax: 020 7271 8001
Contact: Paul Croucher Head Short-Term Products 020 7271 8216 Paul.Croucher@ecgd.gsi.gov.uk www.gov.uk/uk-export-finance
UK Export Finance is the UKs export credit agency, a government department that provides export nance and insurance solutions to help exporters withtheir cash-flow and protect them against not being paid to help fulfil export contracts. Established in 1919 as the worlds rst export credit agency, it complements the commercial market by facilitating exports that may not happen without its support. In 2011, UK Export Finance widened support from its traditional domain of capital and semi-capital goods and related services, to encompass all classes of exports. At the same time, new schemes were targeted at SME and midsized businesses trading on short terms of credit. These products include guarantees to banks that are extending working capital facilities to exporters or issuing contract bonds on their behalf. UK Export Finance has also revised its credit insurance policy that applies to all classes of exports and is accepting business for this scheme introduced through qualied brokers. These schemes run alongside and complement UK Export Finances established products, which primarily give support to exporters wanting to give medium to long credit terms to overseas buyers. In line with the governments export for growth agenda, UK Export Finance has appointed 12 regional Export Finance Advisers, who are based in each region within the UK, in order to make known its support more widely to the exporting community. For more information on the ways UK Export Finance can support exporters, please visit www.gov.uk/uk-export-finance
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TISH EXP RI
TERS A OR
OCIATIO SS
BEXA REPRESENTS YOU

We lobby on behalf of corporate members We can claim much of the credit for the introduction of the successful bond support scheme and other new schemes by UKEF in 2011. We also contribute to official consultations on exports, taking a particular interest in UKEF, export credit insurance, trade finance and the work of UK Trade & Investment.
We provide an exporters forum Members attending meetings of our Industry and SME & Micro Exporter committees discuss issues affecting export markets and share their experiences as SMEs, as large corporates, as users of various trade finance techniques. We hold membership networking events In recent years our Spring Reception has been held at the House of Commons and our Annual Lunch at the Mansion House, London. We disseminate information Through our newsletter, minutes of our Council, Industry and other meetings and focussed e-circulars. We sponsor the GTR BExA Young Exporter Award bringing recognition to capable young exporters and to theircompanies. AND WE PUBLISH GUIDES BY EXPORTERS, FOR EXPORTERS In addition to this Guide to On-Demand Contract Bonds, we have published guides on Successful Exporting, Export Compliance, Retention of Title, Letters of Credit, Export Credit Insurance, and Export Finance. Further information and a membership application form is available on www.bexa.co.uk The British Exporters Association Broadway House, Tothill Street, London SW1H 9NQ hughbailey@bexa.co.uk Tel.: 020 7222 5419 www.bexa.co.uk
The British Exporters Association Broadway House Tothill Street London SW1H 9NQ Tel: 020 7222 5419 Fax: 020 7799 2468 Email: hughbailey@bexa.co.uk www.bexa.co.uk

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The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

Chapter 7 Chapter 8 Chapter 9

Chapter 10 Appendix 1 Appendix 2 Appendix 3 Appendix 4

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

Chapter 1: What is an on demand contract bond?

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

Chapter 1: What is an on demand contract bond?

The BExA Guide to On-Demand Contract Bonds

Chapter 1: What is an on demand contract bond?

The BExA Guide to On-Demand Contract Bonds

Chapter 2: The customers view

The BExA Guide to On-Demand Contract Bonds

Chapter 2: The customers view

The BExA Guide to On-Demand Contract Bonds

Local bank Bond

Counter-indemnity Export contract UK exporter

The BExA Guide to On-Demand Contract Bonds

Chapter 3: The banks view

The BExA Guide to On-Demand Contract Bonds

Chapter 3: The banks view

The BExA Guide to On-Demand Contract Bonds

Chapter 3: The banks view

The BExA Guide to On-Demand Contract Bonds

Chapter 3: The banks view

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

Chapter 3: The banks view

The BExA Guide to On-Demand Contract Bonds

Indemnities in favour of Issuing Bank Bank C Bank D Sub-participants

Chapter 3: The banks view

The BExA Guide to On-Demand Contract Bonds

Customer (beneciary) Issues bond Issuing Bank

Counter-Indemnity in favour of Issuing Bank Bank C

Counter Indemnities in favour of syndicate banks

Chapter 3: The bank's view

The BExA Guide to On-Demand Contract Bonds

Chapter 4: The exporters view

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

The BExA Guide to On-Demand Contract Bonds

Chapter 4: The exporters view

The BExA Guide to On-Demand Contract Bonds

Chapter 4: The exporters view

The BExA Guide to On-Demand Contract Bonds

Chapter 4: The exporters view

The BExA Guide to On-Demand Contract Bonds

Chapter 5: The lawyers view

The BExA Guide to On-Demand Contract Bonds

EWHC 657 (TCC) Akenhead,J

Chapter 5: The lawyers view

The BExA Guide to On-Demand Contract Bonds

Chapter 5: The lawyers view

The BExA Guide to On-Demand Contract Bonds

ii) iii) iv) v) vi)

Chapter 6: What to watch out for and what to avoid

The BExA Guide to On-Demand Contract Bonds