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Performance bonds and bank guarantees are vital in ensuring smooth commercial operations. They act as safeguards for parties engaged in business, particularly in industries like construction and contracting. These bonds assure that obligations will be fulfilled, thereby promoting confidence and stability in commercial dealings. Their use is often described as essential for maintaining trust and ensuring reliable transactions in the marketplace. However, in cases where disputes arise, contractors who have provided bank guarantees may seek the assistance of the court to prohibit the demand on the bank guarantee, in an effort to avoid the relevant sums being made available to the owners.

In the recent judgment in LAKON ATE, Paphos v. Municipality of Paphos, 1186/2023 (2024), the District Court of Paphos analysed the circumstances in which court intervention would be justified in suspending the payment of the bank guarantee.

Background

The case involved a public infrastructure project undertaken by LAKON ATE as the contractor for the Municipality of Paphos, encompassing various facets of public infrastructure development. To secure its obligations, the contractor issued a bank guarantee exceeding €600,000 in favour of the Municipality of Paphos. Disputes arose during the project's execution, leading to the termination of the procurement agreement by the Municipality. In response, the contractor initiated a civil action seeking the invalidation of the bank guarantee, accompanied by an application for an interim injunction prohibiting any demand to the bank by the Municipality of Paphos.

The nature of a public procurement bank Guarantee

A performance bond, often referred to as an execution bond, is a written commitment guaranteeing payment under specified conditions. This bond is crucial in commercial transactions, functioning similarly to cash due to its assured promise of payment. Its primary role is to establish trust and reliability, especially within the contracting industry. The document is considered independent and autonomous, meaning its validity does not depend on the broader contractual relationship between the involved parties. When the terms specified in the bond are met, the issuing financial institution is obliged to make the payment.

The court explained the distinction between conditional bonds and on-demand or unconditional bonds. Conditional bonds require specific conditions or events to be met before payment is made, adding a layer of security to the transaction. Unconditional guarantees or bonds obligate the issuer to pay upon the beneficiary's request without any preconditions, providing straightforward and immediate assurance of payment. The specific nature and terms of a performance bond are detailed within the bond document itself, clarifying the conditions under which payment will be made.

The reliability of performance bonds lies in their enforceability. Once issued, these bonds are treated as assured financial commitments, ensuring that the specified payment will be made if conditions are met. This reliability makes performance bonds an indispensable tool in both domestic and international trade, providing a foundation of trust and security that facilitates smooth and confident commercial interactions.

The Judgment

In this case, the performance bond/guarantee issued by the National Bank of Greece was irrevocable and independent of any disputes between the contracting parties. It represented a commitment by the issuing bank to pay the beneficiary (the defendants) the guaranteed amount upon request, subject only to proof of fraud. The court explained that it is only in exceptional cases that courts will interfere with the irrevocable obligations assumed by a bank, such as in clear cases of fraud. Assessing the evidence from a provisional point of view and without making any findings that are not appropriate in interim injunctions, the court concluded that there were no sufficient grounds to allege fraud in this instance and, therefore, decided to annul the injunction.

The court also agreed with the defendants' lawyers that the interim injunction should be annulled because the demand on the bank guarantee was already executed before the issuance of the injunction on an ex parte basis. Since the bank had honoured its obligations under the guarantee before the injunction was served on the bank, the court found no reason to maintain the injunction.

Conclusion

The court’s analysis sheds light on the circumstances that must exist for a Cyprus court to intervene in relation to demands on performance bonds or bank guarantees. It highlights the substantial hurdle that applicants must overcome to justify court intervention in prohibiting the demand on performance bonds or bank guarantees. Absent clear evidence of fraud, Cyprus courts are hesitant to prohibit or restrain demands on performance bonds or bank guarantees.

The judgment can be found here.

 

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