What to do in case of fraudulent calling of the Performance Bond

19 May 2022

Giuseppe Broccoli

Written by Giuseppe Broccoli

5 MIN READ

The calling of the performance bond is fraudulent when the beneficiary demand the payment to the guarantor without having however the right to do so and being aware of this so that the result will be that the beneficiary will obtain an unfair profit.

 

WHAT TO DO FRAUDULENT CALLING

(this article is an update of our previous blog published in July 2018)

The nature of the Performance Bond (as an on-demand bond) allows in fact the beneficiary to obtain the payment of the agreed sum of money in case of contractual breach from the applicant generally upon simple demand.

 

But what to do in case the calling is fraudulent?

 

We will examine below 5 steps to be followed to try to stop the payment (in case of alleged fraud form the beneficiary), taking into account that the guarantor will often (but not always) refuse the payment of the bond only in case of a Court decision orders the guarantor not to proceed with the payment.

 

The application to the Court is not however the only tool to stop the payment

 

Read below our suggestions on how to act in case of calling of a performance bond

 

 

1. Check if the calling can be considered fraudulent


It seems redundant but, in our experience, the applicant tries with any means to stop the payment, even in those circumstances where it has no legal grounds to do so.

 

If, on one hand, said conduct is comprehensible, on the other hand it is worth noting that the carrying out of aggressive actions without any legal grounds may worsen the situation both towards the beneficiary who called the bond and the bank which issued the same.

The only advantage of said conduct may be that a few days could be bought before the payment (in Italy some weeks at the maximum). Except for in extraordinary cases, said conduct does not take any advantage!

In order to check if the calling of your performance bond may be considered fraudulent, please see our blog on the fraudulent calling of the performance bond, considering in any event that said article contains some generic considerations which may vary case by case.

 

 

2. Carefully read the text of the performance bond to:

  • check that the bank which issued the bond has its registered office in Italy;
  • check the Court eventually competent for issuing an order to the guarantor to refrain from paying the bond amount (normally it is competent the Court where the branch which issued the bond has its registered office);
  • check the deadline for the bank to pay the bond after the receipt of the demand (it is evident that the eventual order to not pay from the Court shall be obtained, at the maximum, the day before the payment deadline for the bank);
  • check the applicable law governing the bond, that is the law to be followed for the construction of the text of the bond (in case of a foreign law, it is advisable to have the opinion from a local lawyer).

The foregoing is necessary to plan the various activities and decide what steps to be taken and the relative timing.

If, for example, the bank is obliged to pay within 5 days from the calling demand, it is evident that any activities to stop the payment shall be planned and completed at least the day before the bank payment deadline.

 

 

3. Send a warning letter to the guarantor bank

If the calling is actually fraudulent, first of all it is necessary to send a warning letter to the guarantor to require the guarantor not to pay highlighting the reasons (with documentary evidence if possible) why that the calling is (considered) fraudulent.

As already mentioned in another article, the fact that the performance bond is an autonomous and an on-demand bond does not mean that the bank is obliged to pay without making any check before said payment.

It is true that the bank cannot evaluate the merit of the contractual relationships and the reasons of the bond calling. In other terms, the bank has not the power to establish if the calling is lawful or not, but it has in any event the obligation to act in good faith and with the due diligence vis-à-vis the applicant (its client) and refrain from paying in all circumstances where the calling is manifestly fraudulent.

This is due to the fact that the bank shall act by virtue of the contractual relationship with the applicant and shall perform a generic (but accurate) control duty, in case of bond calling, and in particular to check if the calling is fraudulent or not.

This is the reason why the guarantor must be promptly informed of all factual circumstances on the basis of which the calling can be considered fraudulent.

In such way, using the due diligence, the guarantor will be able to verify that the calling, from a first analysis, is abusive and fraudulent (in other terms, the guarantor will have all the instruments to verify that the calling is fraudulent).

Just after the sending of the warning letter to the guarantor, it is advisable to take promptly contact with the bank to understand whether the intention of the bank is pay the amount under the bond or not. In the majority of the cases, the banks are inclined to pay unless they receive an order from the Court not to pay.

For such reason it is necessary, in all cases where the bank does not clearly and exactly express its intention, to make immediate application to the competent Court so that it will order (if the due requirements are met) to the bank to not pay the amount of the performance bond.

 

 

4. Discuss, if possible, with the beneficiary

It not always possible to discuss with the beneficiary, but in the majority of the cases (and except for an evident breach of the applicant) the performance bond is called after long and exhausting discussions between the parties on the quality and seriousness of the breach.

Often the parties achieve an interim agreement pursuant to which they will closely monitor the performance of the contract and, in certain cases, there is a greater interference from the beneficiary (such as in case of plants construction contracts or works contracts in general).

In the worst case, the applicant can obtain a suspension or revocation of the calling by offering in exchange the payment of advance penalties or similar things.

 

 

5. To file an application before the competent Court


If the warning letter or the discussions with the beneficiary do not achieve the expected result, then the only alternative for the applicant is to file an application before the competent Court to obtain an urgent measure by way of which the bank is ordered to refrain from paying.

It is worth noting that, as mentioned before, it is necessary to take into consideration not only the law applicable to the bond but also the nationality of the bank which issued the same.

This is due to the fact that any application for the issue of an urgent measure shall be addressed to the bank which issued the bond and not against the beneficiary.

This is the direct consequence of the fact that the bond is issued on the basis of the contract between the bank and the applicant.

 

6. Conclusions


To conclude, it is advisable to:

  1. carefully verify if the calling is fraudulent;
  2. send a warning letter to the bank together with all the documentation useful for the bank to ascertain, from a first analysis, that the calling is fraudulent;
  3. start discussions both with the bank and the beneficiary which called the bond;
  4. to file, if all the other attempts failed, a recourse before the competent Court for the issuing of an order to the bank of not to pay the amount under the bond.

 

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