The Court of Appeal has held that a beneficiary of an on demand performance bond acquires a complete and immediately enforceable cause of action against the issuing bank as soon as a valid demand is made. The beneficiary is under no obligation to hold the bond amount on trust in favour of the bank pending the successful outcome of its claim under the underlying contract.
In other words, there is no implied term in a bond requiring repayment by a beneficiary to the bank of the bond amount if the beneficiary does not ultimately prove its case against the contractor under the underlying contract.
The case before the Court of Appeal concerned the issuing bank making a payment under an on demand performance bond in favour of a shipbuilder beneficiary (the seller) upon the failure by a buyer to make due and punctual payment. The seller made a demand for payment against the buyer in respect of an instalment it considered due under the contract. Payment was not made and so the seller made a demand in good faith under the bond. Payment was made by the bank before it was subsequently finally determined by way of arbitration that the instalment was not due from the buyer to the seller. The bank sought an order that the money paid out under the bond was held on trust by the seller in favour of the bank and alternatively in favour of the buyer.
The Court concluded that there is no trust in favour of the bank; it is critical for the efficacy of such arrangements that the position crystallises at the presentation of the demand, subject to the obvious exception of a fraudulent demand.
In the absence of clear words to the contrary the parties to the underlying contract will often conduct their own accounting exercise once their dispute has been resolved. This will take into account the amount that has been paid by the bank under the bond.