Business Law Articles
By: Emwanta Ehigiato & Osayaba Giwa-Osagie
Giwa-Osagie & Company
Ikoyi, Lagos Nigeria
The purpose of a bond is to provide some financial security in the form of a cash sum payable by the surety for the contractor’s failure to perform his obligations under a contract. A bond instrument may be executed by the government, a company, an individual or any other business entity, guaranteeing the performance of contractual obligations.
The use of bonds is a common feature of government contracts in Nigeria where the government wishes to ensure that persons who submit bids for such contracts have requisite technical and financial resources to perform their obligations thereunder. Furthermore, in construction contracts the owner of the project may want to be sure that payment made to the contractor are used strictly for the purpose of the contract and not diverted. These assurances and commitments have come to be known as tender bonds, bid bonds, performance bonds and advance payment bonds. In Welco Industriale S.P.A v J.I Nwanyanwu & Sons Enterprises Ltd (2005) 3 FWLR (Pt. 270) PP173-174, the Court of Appeal held that a bond is a contract under seal to pay a sum of money, and the person who binds himself is called the obligor or surety and the person in whose favour the bond is given is called the obligee.
The types of bonds commonly used in Nigeria are highlighted below.
1). Judgment Debt Bond. This guarantees the payment of a judgment debt. Thus in Ojomu & Ors v Breitenburger Portland Cement,(1959)NSCC232, Brett F.J of the Supreme Court of Nigeria held that a surety of a judgment creditor becomes subrogated to all the rights possessed by the judgment creditor in respect of the debt guaranteed where the judgment debtor had failed to execute the bond.
2. Fidelity Insurance Bond. This is an insurance policy aimed at protecting the insured against the contingencies of a breach of honesty and good faith on the part of a person in whom confidence has been reposed. An illustration is where an employee is in a position of trust requiring him to keep money or securities such as a cashier or a sales person. In Nigeria some employers of labour insist on having fidelity guarantees especially for employees who occupy sensitive positions whose acts or omissions may result in considerable financial losses to the employers. Fidelity insurance may be required by statute such as the Nigerian Deposit Insurance Corporation Act, which provides that any licensed bank or such other financial institution which insures its deposits with the Corporation shall be required to provide a fidelity bond coverage. Also fidelity bond may be required by regulation, for example, it is a condition for registration of Capital Market Operators by the Securities and Exchange Commission in Nigeria that such Operators must take out fidelity bonds in respect of their employees.
3. Credit Bond. A credit bond is an agreement or a commitment made by a surety jointly with its client (debtor) to be answerable for the discharge of the client’s obligations to a third party (creditor).The surety and debtor usually act as co-sureties as both agree to be jointly responsible for the discharge of the debtor’s financial obligations to the creditor. However in an action for enforcement of a guarantee the creditor can proceed solely against the guarantor without having to join the principal debtor in the suit whereas in a credit bond the surety and the debtor need to be joined based on their joint liability. This point was acknowledged by the Supreme Court of Nigeria in Fortune International Bank Plc. v Pegasus Trading Office & 2 Others,(2004) All FWLR(Pt1999)P1323. In practice a credit bond may contain some clauses onerous to the lender such as fixing a short time frame for instituting an action or making it a deficiency guarantee. Properly construed, a credit bond may not be worth more than the paper on which it is written. Consequently, the creditor’s solicitor needs to exhibit a high degree of diligence and professional competence in vetting a credit bond. If the bond falls short of the legal requirements he should advise the creditor not to accept same.
4. Bonds in international and local construction contracts. The various bonds usually used in international and local construction contracts are as follows:
i). Tender Bonds. These are given at the pre-tender stage by the surety on behalf of the contractor guaranteeing the contractor’s ability to perform the contract in the event that the contract is awarded to the contractor.
ii). Bid Bonds. In a bid bond, the bidder (contractor and surety) usually agree to be firmly and jointly bound to pay a specified sum of money to the employer during the period of bid validity on the occurrence of certain events or conditions. From the perspective of the surety, it is a good drafting technique for the bid bond to provide for an expiry date after which no claim can be made under the bond otherwise the surety’s position will be prejudiced as its liability in such a situation will be endless. From the view point of the employer a well drafted bid bond should contain a provision to the effect that the amount guaranteed under the bid bond will be paid to the employer upon receipt of its first written demand without the employer having to substantiate its demand.
iii). Advance Payment Bonds or Repayment Guarantees. Advance payment bonds are given by the surety after the pre-tender stage when the contract must have been awarded to the contractor or bidder. Advance payment bonds ensure that an agreed percentage of the contract sum is paid in advance to the contractor on the strength of the surety’s undertaking, or guarantee to refund such proportion of the said advance payment received from the employer representing the value of work not done in the event of the contractor failing to fulfill the terms of the contract. It is good drafting technique to include a provision to the effect that the surety’s liability will continue to diminish by the value of work done under the contract. The value of work is usually certified by an architect, engineer or some other professional acceptable to the surety, the employer and the contractor. This provision is just and fair as equity will not allow the employer to benefit from unjust enrichment by claiming the full amount guaranteed by the surety notwithstanding the fact that there has been a partial performance of the contract by the contractor.
iv). Performance Bonds. Performance bonds guarantee execution of the contract by the surety in the event that the contractor fails to fully perform the contract .In African Development Insurance Corporation v Nigeria Liquefied Natural Gas Limited (2000)4NWLR(Pt653)SC494 at page 495, the Supreme Court of Nigeria explained the meaning of performance bond as follows:
‘’Performance bonds are bonds to secure performance of a principal contract. Such bonds may be classified according to the obligations undertaken------In some cases it is a conditional guarantee while---it is sometimes called a first demand bond or an on demand bond’’
From the foregoing, a performance bond may be conditional or unconditional a fact which was also acknowledged in the case of Welco Industriale S.P.A v I.I Nwanyanwu & Sons Enterprises (Nig) Ltd (Supra), the court alluded to the aforementioned classification of performance bond.
5. Defences available to a surety under a bond. Some of the defences available to the surety are stated hereunder.
a). Actions by the owner or employer that prejudice the surety’s rights may release the surety.
b). Failure by a claimant to meet obligations specified in the contract.
c). The bond was not signed, sealed, or delivered to the parties to it.
d). A claimant is required to give prompt notice of the contractor’s default to the surety failing which the surety may be discharged from his obligations.
e). An owner or employer is not permitted to increase the surety’s risk without the latter’s consent, a material or significant change in the bonded contract without the consent of the surety will release the surety unless the change is beneficial to the surety. Be that as it may, consent to a variation will be implied if there are provisions in the contract for variation of work.
6. Conclusion and recommendations. Bonds are important security instruments in local and international business transactions. They are crucial in enhancing the performance of contracts due to the additional assurances contained therein. From the perspective of the surety the risk inherent in an unconditional bond can be minimized by including the following provisions:
a). No claim shall be met by the surety unless accompanied by a court or arbitration award under the Arbitration and Conciliation Act Cap A18 Laws of the Federal Republic of Nigeria 2004.
b). Specification of the documentation supporting claims by the beneficiary.
c). Stating clearly that the bond must be returned to the surety on a definite expiry date.
d). The bond should be devoid of ambiguities to ensure that the intention of the parties can easily be ascertained.
It is suggested that a potential claimant should exercise care when making a claim and the following are pertinent:
a). The claimant needs to speak to the surety preferably through his solicitor
b). A formal claim must be made strictly in line with the terms of the bond and claimants should ensure that they act promptly to avoid potential liens on the contract from subcontractors or other interested parties
c). There should be utmost caution with respect to remedial steps that have the potentials of prejudicing the surety’s rights. The owner should not complete work and later ask the surety to pay the costs of completion
d). It is necessary to carefully review the underlying contract to avoid possible argument of non-compliance.
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