A Performance Security Bond (Performance Bond) is a contract of guarantee in which one party (the Guarantor) promises to discharge the liability of a third party in the event of default. Performance Bonds are designed to ensure the performance of duties by parties to a contract. In this month’s legal update, we highlight the key aspects of Performance Bonds and their implications in Tanzania.
The following laws are applicable to this article:
- The Banking and Financial Institutions Act No. 5 of 2006 (the BFI Act)
- The Law of Contract Act, Cap 345 R.E. 2019 (the LCA)
- The Public Private Partnership Act No. 18 of 2010 (as amended)
- The Public Procurement Regulations, GN No. 446 of 2013 (as amended) (the Regulations)
Performance Bonds are governed by the provisions of the LCA. It should be noted that banks and financial institutions are among the main providers of Performance Bonds in Tanzania alongside insurance companies. Banks and financial institutions are permitted to issue guarantees pursuant to section 24 (1) (f) of the BFI Act.
How Performance Bonds are commonly used in Tanzania
In Tanzania, Performance Bonds are commonly used in public-private partnerships (PPPs) where a Government agency/authority (the Beneficiary) seeks expertise from a private entity (the Supplier). Under such circumstances, the Beneficiary would require the Supplier to obtain a Performance Bond as a guarantee to perform the required services.
The submission of a Performance Bond under the PPP regime is provided for under regulation 29 (1) of the Regulations which provides as follows:
“(1) The procuring entity shall require the successful tenderer to submit a performance security to guarantee the faithful performance of the contract and payment of all labourers, suppliers, mechanics and subcontractors, if any”.
Pursuant to Regulation 29 (4) of the Regulations, Performance Bonds may be issued in any of the following forms:
- Cash, certified cheque, cashier’s or manager’s cheque, or bank draft.
- An irrevocable letter of credit issued by a reputable commercial bank, or a confirmation letter from a reputable commercial bank in case an irrevocable letter of credit is issued by a foreign bank.
- A bank guarantee confirmed by a reputable local bank or bonded by a foreign bank in case the successful tenderer is a foreigner.
- A surety bond called on demand issued by any reputable surety or insurance company.
Implications of Performance Bonds in Tanzania
One of the major implications of a Performance Bond arises where the Supplier fails to uphold the terms of the contract. Under this circumstance, the Guarantor will be placed under a duty to pay the amount stipulated in the Performance Bond. This position has been upheld by various English law cases such as Edward Owen Engineering Limited versus Barclays Bank International Limited [1978] QB 159 in which the court was of the view that a bank which gives a performance guarantee must honor that guarantee according to its terms. This is regardless of the relationship between the Supplier and the Beneficiary and whether the Supplier actually defaulted - if indicated as such in the Performance Bond. This means a Guarantor has a duty to pay on demand and without demanding proof of default by the Supplier.
In Tanzania, the above position was maintained in the case of Tanchi Brothers Construction Company Limited versus Amana Bank Limited, Miscellaneous Commercial Cause No. 28 of 2020 in which the court further added that a bank will be restrained from performing its obligations under an unconditional bank guarantee where there is proof of fraud of which the bank has notice.
It is important to note that enforcement of Performance Bonds is a commercial arrangement which can be mutually agreed upon by parties to the contract. In some instances, the Beneficiary will be required to prove default by the Supplier and further prove that the security amount was claimed within the validity period as it was upheld in the case of Akiba Commercial Bank PLC versus UAP-Insurance Tanzania Limited, Commercial Case No. 24 of 2018. In proving that a claim is within the validity period, time is of essence.
Aside from the existence of fraud, a Guarantor may be exempted from paying the security amount stipulated in a Performance Bond where the Supplier carries out an act which is inconsistent with the rights of the Guarantor or omits to do an act which it is bound to do. A Guarantor will be discharged from paying the security amount if such an action or inaction impairs the payment that was to be issued by the Guarantor to the Beneficiary as provided under section 91 of the LCA. Furthermore, it is a common law position that a Guarantor cannot rely on any rights or defences available to the Supplier to avoid its liability to pay the Beneficiary.
Sections 85 to 87 of the LCA provide other options wherein a Guarantor can be discharged:
- Where the terms of the contract between the Supplier and the Beneficiary are varied without the Guarantor’s consent. This discharges the Guarantor as to transactions following the variance.
- By any contract between the Beneficiary and the Supplier, which results in the Supplier being released, or by any act or omission of the Beneficiary.
- By a contract between the Beneficiary and the Supplier, in which the Beneficiary makes a composition with, or promises to give time to, or not to sue, the Supplier. This discharges the Guarantor unless the Guarantor assents to such contract.
Performance Bonds contain an implied condition that the Supplier will indemnify the Guarantor for any sum rightfully paid under the Performance Bond by virtue of section 97 of the LCA. There is a risk that Suppliers may challenge the indemnification of the Guarantor and this usually places the Guarantor in a detrimental position. In order to protect the Guarantor from loss, it is important to include a clause in the Performance Bond which clearly defines the parameters of the Performance Bond and also provides for the indemnification of the Guarantor.
In a nutshell, Performance Bonds are becoming more common as they have proved to protect parties to a contract from suffering loss, however, to ensure that no party suffers detriment, we advise that the terms of Performance Bonds be framed to protect not only the Beneficiary in case of default of the Supplier but also the Guarantor to ensure full indemnification for amount rightfully paid in accordance with the terms of the Performance Bond.
--
Read the original publication at Clyde & Co.