Performance bond as on-demand guarantee.

The Performance Bond is an on-demand guarantee (or rather, under Italian Law, it is an ‘autonomous’ and at first demand' guarantee) by virtue of which the beneficiary (as buyer or owner) can obtain a certain amount of money on the basis of a simple request submitted to the guarantor declaring that the other party has breached some of its contractual obligations.

No need for the beneficiary to prove the actual default.

To be precise, it must be highlighted that under Italian Law the expression ‘at first demand guarantee’ is used improperly, in the sense that the expression ‘at first demand’ represents a clause that is almost always included into Performance Bond but does not identify the real nature of the bond itself and does not automatically identify it as an autonomous bond.

Let's try to understand what this means.

In another article we have explained the difference between autonomous guarantee and conditional guarantee (or surety) which basically consists in the fact that, while the autonomous guarantee is independent from the underlying contract (and, therefore, the bank will not be able to raise the objections based on the underlying contract itself), the conditional guarantee follows all the events of the underlying contract and, therefore, the bank is entitled to refrain from paying if there is a valid reason based on the underlying contract.

Under Italian Law, a conditional bond can be called at first demand despite the applicant and/or the guarantor can raise any objection based in the underlying contract..

When, under Italian Law, we say that the performance bond is ‘at first demand’, we do not identify its nature (autonomous or conditional) but only

the terms and conditions of its calling.

It must be said, indeed, that in the international context we simply talk about ‘on-demand guarantee’ and, considering that these guarantees are widely spread in the international contracts, it is clear the reason why there is now, even in Italy, a tendency to call the autonomous guarantees simply ‘on-demand bonds’.

Therefore, under Italian Law, a performance bond must be properly construed as both a 'first demand' and 'autonomous' guarantee and must contain appropriate clauses to make it clear that it not only can be called with a simple demand but that neither the applicant nor the guarantor can raise any objection based on the underlying contract.

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The specificity of the ‘at first demand’ clause allows, as mentioned, the beneficiary to request the payment of the bond by submitting a simple demand in which it is declared that the other party is in breach of its contractual obligations without having to prove the default of the other part.

The bank, in its turn, will be obliged to pay within a certain number of days (indicated in the text of the performance bond) from the receipt of such demand.

In principle, the bank is not entitled to suspend the payment of the performance bond (in its ordinary form of an autonomous on-demand guarantee) except for the following cases:

• the request of payment is made in a different way from that required by the performance bond, such as:
  • the bond provides that the calling must be sent to the branch that issued the performance bond and, instead, the beneficiary sends the request of payment to the registered office of the bank; or
  • the bond provides that the calling must be transmitted through another bank or by courier and, instead, the request of payment is sent by e-mail.

• the payment request is manifestly unlawful, for example because the supply or commissioned works have been correctly executed and no objections have been raised. This is the case of the so-called abusive or fraudulent calling of the performance bond.

Therefore, the letter that will be sent to the bank to obtain the payment must be accurately drafted to avoid that the bank refrains from the payment due to formal mistakes or because what the performance bond provides has not been accurately executed.

It is clear that, the “at first demand” clause allows the beneficiary to achieve immediately two following goals:

• to obtain the payment in a quick way and without too many formalities; and

• to avoid submission of the evidence of the other party’s default at the moment of the payment request (which, for instance, in works contracts would require long and complicated evidence).

However, there are cases in which the performance bond is not at first demand.

The clauses operating in the opposite sense are usually called “at documented demand” or “at justified demand”.

We refer to all those cases where the calling demand must:

1. be accompanied by additional documents (for example, the declaration or certification of a third party, usually an independent one, who declares the failure to supply or to execute works subject to the contract). In this case we talk about a bond with the clause ‘at documented demand’;
2. be justified, i.e. the calling demand must contain clear indications of the default of the other party. In this case we talk about a bond with the clause ‘at justified demand’.

Pay attention, because, even if the performance bonds contain ‘at documented demand’ or ‘at justified demand’ clauses, they do not turn into a surety (or a conditional guarantee), but still remain an autonomous guarantee: i.e. the bank will not have to verify the truthfulness of what is stated into the additional documents drawn up by third party (nor this document must prove the breach of the contract, but only declare it), but will have to limit itself to verify that the beneficiary has delivered, in addition to the calling demand, the document drafted and signed by the third party.