Member Article

Reliance on performance guarantees in infrastructure projects has gained traction in Uganda in recent years. A performance guarantee is a legal promise made by one party to another, and typically backed by a third-party financial institution, to ensure fulfilment of contractual obligations. Its main purpose is to safeguards a beneficiary, usually the employer, against the non-performance, delayed or inadequate performance by a contractor, usually the employee and allows quick access to funds which sit with a third party to remedy the breach occasioned by the employee.

It is common for contractors in default to seek court orders against banks from making payments upon demand. The courts have long taken a firm stance on the matter and have consistently applied the correct commercial law principles as we show below.

The strict enforcement approach: pay first argue later

Courts in Uganda have upheld the autonomy of on-demand performance guarantee and held that it imposes a primary obligation on the issuer (usually bank or an insurance company) to pay the beneficiaryon demandwhere the contractor fails to fulfil their obligations. The issuer's obligations are not affected by disputes in the underlying contract between the beneficiary and the contractor and the beneficiary is entitled to payment simply by making a demand on the issuer. The beneficiary is not required to prove a default by the contractor of the underlying construction contract. The statement “pay first and argue later” best describes the underlying principle in an on-demand guarantee.

InAC Yafeng Construction Limited v The Registered Trustees of the Living Word Assembly Churchfan attempt by the principal (applicant) to stop the guarantor (bank) from paying monies due under an on-demand performance guarantee to the project owner (beneficiary) was denied by the court which ruled that as long as the project owner had made a request for payment, the bank must pay the money under the unconditional guarantee, and so the principal's attempt to stop payment was unsuccessful.

These principles have been applied in other similar cases includingRoko Construction Limited v The Aga Khan UniversityandNational Housing & Construction Company Limited v Lion Assurance Company Limited.

The reluctance by the courts to make orders restraining payments under performance guarantees is because guarantees and other security instruments such as letters of credit contain an assurance of payment to the beneficiary in the event of default (for performance guarantees) and where the beneficiary has presented compliant documents (for letters of credit). Courts have long hailed these instruments as the “lifeblood” of international commerce’.

The exceptions to the rule

The recent High Court decision inUganda Electricity Transmission Company Limited v Citibank Uganda Limiteddiscusses the exceptions to the autonomy of on-demand guarantees.

The Court may intervene and make orders restraining the guarantor from making payments under a demand guarantee in the following exceptional circumstances, such as:

• fraud affecting the documents presented by the beneficiary (for example if the documents have been forged);
• illegality in the demand guarantee contract or the underlying contract;
• an Infringement of international obligations and express contractual derogation from the principle of autonomy; and
• Total failure of the basis of the contract.

With the assurance from the courts, players in the construction industry can carry on business seamlessly with confidence that the courts will hold contractors to their obligations and will be slow to halt enforcement of the payment guarantees. An enabling business environment stimulated by this assurance is likely to spur even better progress for the economy.

Reviewed by Phillip Karugaba, a partner at the ENSafrica.

Sheila Pacuto

Senior Associate

[email protected]

Emmanuel Ankunda

Associate

[email protected]

 

Link to article