On demand bonds: getting it right first time

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

In the recent case Caterpillar Motoren GmbH & Co K.G. (Caterpillar) v Mutual Benefits Assurance Company (MBAC) [2015] EWHC 2304 (Comm), the Commercial Court considered the construction of an advance payment guarantee and a performance bond in order to determine whether each document was an “on demand” bond (i.e. MBAC was liable on presentation of a compliant demand) or whether they were bonds in the nature of a true guarantee (whereby Caterpillar would be required to prove MBAC's liability by way of admission from the contractor, concession by MBAC or by an arbitration award).

The court held that it was “beyond doubt” that each bond was an on demand bond despite the fact that:

a) the advance payment guarantee contained the word “guarantee” in the title and within the operative provisions. This was on the basis that the document went on to provide that the “decision of [Caterpillar] as to whether the contractor has made any such default will be binding on [MBAC]” and that MBAC was not entitled to require Caterpillar to establish its claims but shall pay “forthwith on demand”.

b) the performance bond contained language which was “suggestive of a true guarantee”. This contradicted further provisions where MBAC was liable once Caterpillar had declared that the contractor was in default, MBAC's liability is unconditional and that any such “demand made on [MBAC] shall be conclusive”.

This case highlights the importance of clear drafting and particularly in the current market where on demand bonds are themselves only available at a considerable extra cost, employers should carefully construe any security document to ensure that it can be called on without further time and cost in establishing the contractor's liability.