INSURANCE GUARANTEE
By
M.
ZEESHAN ABDULLAH
Advocate
This paper would
explore the legal concept with reference to the contract of Guarantee in light
of relevant case laws;
Guarantee (Noun) A formal promise or assurance
(normally in writing) that certain conditions be fulfilled, especially, that a
product will be repaired.
Guarantee (Verb)
Provide a formal assurance or promise, especially, that certain conditions
shall be fulfilled relating to a product, service, or a transaction.
A Contract of
guarantees normally known and called as guarantee, surety, warranty, security,
bail, pledge, performance bond and mobilization advance bond etc.
History of
guarantee bonds / surety bonds is that an individual surety bond was the
original form of surety-ship. The earliest known record of a contract of
surety-ship is a Mesopotamian tublet written around 1790 BC. There is evidence
of Individual Surety Bonds in the Code of Hammurabi and in
In
Therefore for
making a legitimate contract of guarantee there should be three persons who are
called, as far their status in a contract of guarantee, as "Surety/Guarantor". "Principle Debtor" and "Creditor".
In strict sense
a business of insurance, explicitly, does not cover a contract of guarantee
which are now being issued by the insurance companies, in other words, an
insurance guarantee, in early stages, was not a common product of insurance companies
as insurance is based on a mechanism known as risk pooling or a group sharing
of losses and in legal sense an insurance is a contract of indemnity governs by
Section 124 of Contract Act 1872.
That
the common insurance products are Auto Insurance, Fire Insurance. Marine Insurance. Health Insurance, Life Insurance and Miscellaneous Insurance.
Now
insurance companies also issue insurance guarantee(s) in different shapes like Performance
Bonds, and Mobilization Advance Bond etc. and charge specified charges for the
same. Although by virtue of
Section 145 of the Contract Act, 1872 a Guarantor/Surety always indemnified
that in every contract of guarantee there is an implied promise by the
principle debtor to indemnify the surety that he/she is entitled to recover
from the principle debtor whatever sum the Guarantor has rightfully paid under the
guarantee, but, besides, almost all the Insurance Companies, while issue
guarantee/performance bond/ mobilization advance guarantee get securities from
the principle debtor in order to secure the guaranteed amount. Such securities
may be in different shapes like; cash margin deposit, Counter Guarantee. Promissory Notes, undated Cheques and mortgaged of properties etc.
Section 141 of
the Contract Act, 1872 provides that a Guarantor/ surety is entitled to the
every security which the creditor (in whose favour such guarantee is issued)
has against the principle debtor at the time when the contract of surety-ship
is entered into. Such entitlement is irrespective of fact that the surety
having knowledge of existence of such security or not and if the creditor
losses, or without the consent of the surety parts with such security, the
surety would be discharged to the extent of the value of the said security.
The provisions of
Section 142 and 143 provide some exceptions to the validity of a contract of
Guarantee as the former Section gives a safeguard to a Guarantor that if
guarantee obtained by means of misrepresentation made by the creditor, or such
misrepresentation was in his knowledge and he assented concerning a material
fact of the transaction such contract of Guarantee shall be invalid, and later
Section provides a shield o/" protection to a Guarantor from whom
guarantee has been obtained by concealment as to material circumstances, which
renders such Guarantee invalid.
In
a contract of Guarantee, if not provided otherwise, the liability of a surety
always coextensive with that of the principle debtor, however. Section 140 say that if on
default of principle debtor the Guarantor pays all the amount he is liable for.
the surety shall be invested with all the rights, with
the creditor had against the principle debtor/
European Surety
bonds are issued by the banks and are called "Bank Guarantee" in English and "Caution" in French.
In a contract of
Guarantee if principle debtor commits default in performance of his obligations
and the surety terms out to be insolvent, the purpose of the Guarantee is
rendered nugatory, therefore, the insurance Guarantee is usually obtain from insurance
companies whose solvency are verified by private audit, governmental
regulations or both.
A key term, in
nearly every Guarantee, including Performance Bond and Mobilization Advance
Bond is the penal sum. A specified amount of money which is
the maximum amount that the surety will be required to pay in the event of the
principle debtor's default in performance of his obligations). That such
specified amount of money enables the Guarantor to assess the risk involved in
giving the Guarantee, the premium charged is determined accordingly.
Contacts Bonds
(Performance Guarantee and Mobilization Advance Bond) used mostly in the
construction industry, are a guarantee from a Surety
to a project owner that the contractor (Principle Debtor) will adhere the provisions
of a contract.
This category included:
i) Bid
Bonds (Guarantee that a contractor will enter into contract if awarded the
bid).
ii) Performance
Bond (Guarantee that a contractor will perform the work as specified by the contract)
iii)
iv) Payment Bond (Guarantee that a contractor will pay for
services and materials.)
v) Maintenance
Bond (Guarantee that a contractor will provide facility repair and upkeep for a
specified period of time)
There are also
other miscellaneous contract bonds that do not fall within the categories
above, the most common of which are subdivision and supply bonds;
i) COMMERCIAL
SURETY BONDS;
(a) License and Permit Bond.
(b) Court Bond.
(c) Public Official Bond.
(d) Miscellaneous Bond.
ii) FIDELITY
BONDS,
i) COMMERCIAL
SURETY BONDS
They are
generally divided into four sub-types: License and Permit, Court, Public
Official and Miscellaneous
LICENSE AND PERMIT BONDS
License and
permit bonds are required by certain federal, state, or municipal governments
as prerequisites to receiving a license or permit to engage in certain business
activities.
These bonds
function as a guarantee from a Surety to a government and its constitutions
(Obligee) that a company (Principal) will comply with an underlying statute,
state law, municipal ordinance, or regulation.
Specified
examples include:
·
Contractor's
license bonds, which assure that a contractor (such as a plumber, electrician,
or general contractor) complies with local laws relating to his field.
·
Customs bonds,
including importer entry bonds, which assure compliance with all relevant laws,
as well as payment of import duties and taxes.
·
Tax bonds, which
assure that a business owner, will comply with laws relating to the remittance
of sales or other taxes.
·
Reclamation and
environmental protection bonds.
·
Broker's bonds,
including Insurance, Mortgage, and Title Agency bonds.
·
ERISA (Employee
Retirement Income Security Act) bonds.
·
Motor vehicle
dealer bonds.
·
Money transmitter
bonds.
·
Health spa bonds,
which assure that a health spa will comply with local
laws relating to their field, as well as refund dues for any prepaid services
in the event the spa closes.
COURT BONDS
Court bonds are
those bonds prescribed by statute and relate to the courts. They are further
broken down into judicial bonds and fiduciary bonds. Judicial bonds arise out
of litigation and are posted by parties seeking court remedies or defending
against legal actions seeking court remedies. Fiduciary, or probate, bonds are
filed in probate courts and courts that exercise equitable jurisdiction; they
guarantee that persons whom such courts have entrusted with the care of others*
property will perform their specified duties faithfully.
Examples of
judicial bonds include appeal bonds, supersedeas bonds, attachment bonds,
replevin bonds, injunction bonds. Mechanic's lien bonds, and bail bonds.
Examples of fiduciary bonds include administrator, guardian, and trustee bonds.
PUBLIC OFFICIAL BONDS
Public official
bonds guarantee the honesty and faithful performance of those people who are
elected or appointed to positions of public trust. Examples of officials
sometimes requiring bonds include: notaries public, treasurers, commissioners,
judges, town clerks, law enforcement officers, and Credit Union volunteers.
MISCELLANEOUS BONDS
Miscellaneous
bonds are those that do not fit well under the other commercial surety bond
classifications. They often support private relationships and unique business
needs. Examples of significant miscellaneous bonds include: lost securities
bonds, hazardous waste removal bonds, credit enhancement financial guarantee
bonds, self-insured workers compensation guarantee bonds, and wage and
welfare/fringe benefit (
FIDELITY BONDS
Fidelity bonds,
also known as employee dishonesty coverage, cover theft of an employer's
property by its own employees. Though referred to as bonds,
fidelity coverage functions as a traditional insurance policy rather than a
surety bond.
PERFORMANCE BOND
A performance
bond is a surety bond issued by an insurance company or a bank guarantee
satisfactory completion of a project by a contractor.
A job requiring
a payment & performance bond will usually require a bid bond, to bid the
job. When the job is awarded to the winning bid, a payment and performance bond
will then be required as a security to the job completion.
For example, a
contractor may cause a performance bond to be issued in favor of a client for
whom the contractor is constructing a building. If the contractor fails to
construct the building according to the specifications laid
out by the contract (most often due to the bankruptcy of the contractor), the
client is guaranteed compensation for any monetary loss up to the amount of the
performance bond.
Performance
bonds are commonly used in the construction and development of real property,
where an owner or investor may require the developer to assure that contractors
or project managers procure such bonds in order to guarantee that the value of
the work will not be lost in the case of an unfortunate event (such as insolvency
of the contractor). In other cases, a performance bond may be requested to be
issued in other large contracts besides civil construction projects.
The term is also
used to denote a collateral deposit of good faith money", intended to
secure a futures contract, commonly known as margin.
Performance
bonds are generally issued as part of a "Performance and Payment Bond,
where a Payment Bond guarantees that the contractor will pay the labour and
material costs they are obliged to,
Performance
bonds have been around since 2,750 BC and the Romans developed laws of surety
around 150 AD the principles of which still exist.
In
Following are
some of the leading cases on the subject;
Shipyard K. Damen International v, Karachi Shipyard
an8 Engineering works Ltd. reported PLD 2003 SC 191 the Appellant
approached the Apex court of Pakistan against an order by the Sindh High Court
refusing to grant prayer to interim orders to respondents from encashment of
Performance Bank Guarantee. The Honorable Apex Court refused the leave to
Appeal by upholding the Order of High Court of Sindh.
In case of M/s.
Platinum Insurance Company Ltd.
"In
building/construction contracts it is common practice that an employer pays
certain amount as mobilization advance to the contractor upon the execution of
the contract document against an unconditional Bank guarantee or an Insurance
Company guarantee, in order to enable the contractor to commence execution of
the work by bringing at the site the equipment and material. Whereas a
performance bond is executed on behalf of a contractor in order to ensure that
the contract work is completed and in case of failure, the surest who executed
the performance bond has to indemnify the employer. If one was to compare the
language employed in the Performance Bond, it becomes evident that the former
is unconditional, whereas the latter is conditional".
In famous case of
"In our
view, there seems to be preponderance of judicial view that in case of a letter
of credit and an unconditional Bank guarantee, the Court would generally be
reluctant to grant an ad-interim injunction restraining a Bank from honoring
its contractual obligation. However, in exceptional cases where refusal to
grant an ad-interim injunction, will perpetuate fraud or injustice, which
should be apparent from the material on record, the Court may grant an
ad-interim injunction. In our view, the instant case does not fall under the
category of exceptional cases. The Bank guarantee was given against the cash
amount paid by the PIA towards the 10% mobilization advance of the cost of the
contract. The above amount was to be adjusted against the running bills and the
final bill at the rate of 10% which has not been fully adjusted, and,
therefore, the balance amount of the bank guarantee in fact belongs to the PIA.
Under the terms of the Bank guarantee, the Bank has given undertaking to pay
the amount on demand by the PIA without questioning it and without making a
reference to the consultants and, therefore, it will not be just and proper to
grant an ad-interim injunction. However, it will not be just to allow the
encashment of the full amount of the Bank guarantee. Mr. Nasim Farooqui,
learned counsel for the appellant, has submitted that the PIA has withheld two
running bills, namely, 15 and 16 amounting to about Rs. 20,00,000. Even if the
above bills are to be taken into consideration for the purpose of adjustment of
the mobilization advance, only 10 % amount of the bills could be adjusted
towards the amount of the Bank guarantee, namely, Rs. 2,00,000 (rupees two
lacs). The question, whether the PIA has illegally withheld the above running
bills or any other amount, will be an issue in the suit. If they have done so,
they will be rendering themselves liable to face the consequences thereof under
the law.
As regards
the performance bond, in our view, the same stands entirely on different
footing than the Bank guarantee and unless and until the Court prima facie
finds that the default was on the part of the consultants, it would not be just
and proper to allow its encashment as the encashment depends on the commission
of default. We have already observed herein above that on the basis of material
available on record, it cannot be said who has committed the default."
In the above
case the learned division bench restrained the encashment of Performance Bond,
however, allowed for the encashment of guarantee/Mobilization Advance
Guarantee.
Similarly, in case of Zeenat Brother (Pvt) Ltd. V. Aiwan-e-Iqbal Authority and 3 others,
reported PLD 1996 Kar. 183 the
learned Single Bench of the Sindh High Court restrained the encashment of
Performance Bond, however, refused to grant injunction against encashment of
Mobilization of Advance Bond.
In another case,
Port Qasim Authority, Karachi K AI Ghurair Group of Companies, reported PLD
1997 Kar. 636, while granting interim injunction against the encashment of
Performance Bond placed reliance upon the above referred reported Judgment and
observed that:
"The
dispute arose and the respondent attempted to encash the bank guarantee as well
as the performance bond. In a welt reasoned judgment after examining the
case-law in great deal Ajmal Mian, C.AH. (as his lordship then was) hold that
no injunction should normally be granted to restrain encashment of an
unconditional bank guarantee issued to cover the amount advanced by way of
mobilization advanced. At the same time it was held that the performance bond
stood on an entirely different footing and it would not be just and proper to
allow its encashment without pri8ma facie evidence of breach of contract.
Judgment was sustained by the Hon'bie Supreme Court in the case reported in
1983 SCMR 379. In another very recent judgment in the case of Zeenat Brothers Vs. Aiwan-e-lqbal Authority PLD 1996
One may now
to refer to the terms of the performance bond quoted in para 3 of this judgment
which clarify that the aforesaid bond become
enforceable only upon breach on contract by the Respondents. As such Mr. Zuberi
is not quite correct when he states that there was an unconditional obligation
on the part of the bank to disburse the amount of the bond. The judgment of the
Hon'bie Supreme Court relied upon by him is clearly distinguishable and the
distinction has been appreciated by the Court itself. Therefore, on this aspect
of the matter, the contention of the appellant fails and we would sustain
finding of the learned Single Judge albeit or somewhat different reasons.
With respect
to the submission of Mr. Yousuf Qasim it is indeed correct that arbitration
agreement does not bind the respondent No. 3 and we entirely agree that the
principle of law enunciated in the judgment cited by him. Nevertheless in view
of the decision that we are recording it is not necessary to state anything
further and the case can be disposed of as being primarily dispute between the
appellant and respondents Nos. 1 and 2.
In view of
the above, the appeal is partly allowed and it is ordered that:-
The parties
shall appoint their respective Arbitrators, who would enter upon the reference
within 15 days from the announcement of this judgment and make their Award
within four months of having entered upon such reference. In case of difference
of opinion the matter would be referred to the Umpire in accordance with the
provisions of the Arbitration Act.
In case a
party fails to appoint an Arbitrator the other party can move a proper
application for appointment of an Arbitrator on the original side of this
Court.
That the
Respondents Nos. 1, 2 and 3 shall not encash the performance bond till the
disposal of the suit which will now, however, proceed in accordance with the
Arbitration Act."
In case of
Messer Continental Cables (Pvt) Ltd. V. Messer China Harbor Engineering Co.
Ltd, reported 2011 CLD 1625 the learned Single Bench
of Sindh High Court granted interim injunction on the encashment of Performance
Bond, observed that:
"It is
well settled by now that no injunction should normally be granted to restrain
encashment of an unconditional Bank guarantee issued to cover the amount
advanced by way of mobilization advance. It is also well settled that
performance bond / guarantee stands entirely on different footings. And again,
normally it would not be just and proper to allow its encashment when prima
facie evidence of breach of contract was available. In the case of Pakistan
Engineering Consultants V Pakistan International Airlines Corporation, a
Division bench of this court held that unless there was prima facie evidence of
breach of principal contract, encashment of performance bond was not justified.
The observation of the Division bench of this court in the case under
discussion was upheld by the Hon'ble Supreme Court of
In case of
Messer Atlas Cables (Pvt) Ltd. V. water and power Development Authority & 2
others, reported PLD 2008 Lah. 238 the Petitioner sought
restraining Order by invoking writ jurisdiction under Art. 199
of the Constitution, 1973. The learned Single Bench of the Lahore High
Court dismissed the Writ Petition by observing that;
"
..
in these proceedings under Article 199 of the Constitution of the Islamic
Republic of Pakistan, 1973, such intricate questions pertaining to contractual
regime and controversies cannot be gone into or resolved which necessarily
entail a thorough trial and recording of evidence. Restraint order as prayed
for is not ordinarily issued by the court. This case is not exception to the
ordinary rule. The rational behind is that the bank issuing such a document is considered
to be bound by its own (documents/terms) in respective of other disputes
between the parties. Such a contract (security/performance bond) is to be
construed with reference to its own terms and conditions. In heavy Mechanical
Complex (Pvt) Ltd. Taxila Vs. Attock Industrial Products Ltd. Rawalpindi PLD
2003 Sc 295 on consideration of the precedents it was held that "Rights
and liabilities of parties in case of a contract of guarantee are determined
strictly with reference to terms and conditions of guarantee without recourse
to any other instrument or document executed by the parties for any different
purposes." Moreover, as held by the apex Court in Lahore Cantonment
Cooperative Housing Society Limited, Lahore Cantt's case (supra) the terms of
contract can only be altered or modified by the parties with mutual consent and
whenever there is a dispute arising out of contractual liabilities/obligations
requiring extensive recording of evidence, the forum competent to undertake
that exercise is the civil court. Jurisdiction of the High court under Article
199 of the Constitution of the Islamic
In case of
Guangdong Overseas Construction Group Company Ltd. V. Creek Marine Pvt Ltd.
learned Single Bench of'Sindh High Court, reported 2011 CLD 648 after
a detail survey of the case law on the subject of Performance Bond and
Moblization Advance Bond observed that;
.. In case
of a letter of credit and an unconditional bank gurantee, the Court would generally
be reluctant to grant an ad interim injunction, restraining a bank from
honouring its contractual obligation. However, in exceptional cases, where
refusal to grant an ad interim injunction, will perpetuate fraud or injustice,
which should be apparent from the material on record, the Court may grant an ad
interim injunction.
With regard
to the performance bond, the same stands entirely on different footing than the
bank guarantee and unless and until the court prima facie finds that the
default was on the part of the defendants, it would not be just and proper to
allow its encashment as the encashment depends on the commission of default.
Performance
guarantee stands on footing similar to an irrevocable letter of credit, the
bank which gives performance guarantee must honour that guarantee according to
its terms. It is not concerned in the least with the relations between the
parties to the main contact and as to whether the contractor has performed his
contracted obligation or not, nor with the question whether the contractor is
in default or not. The bank must pay according to the terms of the guarantee
all demands, and if so stipulated, without proof or condition and that the only
exception is a case of clear fraud of which the bank has notice. There is an
absolute obligation upon the banker to comply with the terms and conditions, as
enumerated in the guarantee and to pay the amount stipulated therein
irrespective of any dispute between the parties to the main contract, as to
whether the goods supplied are up to the specification nor not. The bank guarantee
should be enforceable on its own terms and that realization against the bank guarantee
would not affect or prejudice the case of the contractor, if ultimately the
dispute is referred to arbitration and further that the contract of bank
guarantee is an independent contract between the bank and party concerned and
is to be worked out independently of the dispute arising out of the work
agreement between the parties to the work agreement and, therefore, the extent
of the dispute and claim or counter-claims were matters extraneous to the consideration
of the question of enforcement of the bank guarantee. Where the bank had undertaken
to pay the stipulated sum, at any time, without demur, reservation, recourse,
contest or protest, and without any reference to the contractor, no interim
injunction, restraining payment under the guarantee could be granted. Bank
guarantee is an autonomous contract and imposes an absolute obligation on
guarantee becomes due on the happening of a contingency on the occurrence of
which the guarantee becomes enforceable. In the absence of special equities and
the absence of any clear fraud the bank must pay on demand, if so stipulated
and whether the terms are such must be found out from the performance
guarantee, as such. Unqualified terms of guarantee could not be interfered with
by the Courts irrespective of the existence of dispute."
(The author of instant Article is Karachi (Pakistan)
based practicing Advocate and Partner of Senator Mian Raza Rabbani and Saalim
Salam Ansari Advocates Supreme Court of Pakistan in M/s Rabbani & Ansari,
Advocates a leading Law firm of Pakistan.)