Performance bonds and bank guarantees are a common feature of Malaysian construction projects. They give the employer security that the contractor will perform, and they can be called upon if something goes wrong. But they are also a frequent source of dispute, particularly when a contractor believes a bond is being called unfairly. Understanding how these instruments work is essential for both contractors and employers.

What a performance bond is

A performance bond is a financial security, often provided by a bank or insurer, that backs the contractor’s obligation to perform the contract. If the contractor defaults, the employer can call on the bond to recover money, up to the bonded amount, to cover its losses.

The bond gives the employer comfort that there is a source of funds to draw on if the contractor fails to deliver. For the contractor, it represents a contingent liability, money that can be called away if a default is alleged.

On-demand versus conditional bonds

Not all bonds are the same, and the distinction matters enormously. Broadly, bonds fall into two categories. An on-demand bond can generally be called simply by the employer making a demand in the required form, without first having to prove the contractor’s default. A conditional bond, by contrast, typically requires the employer to establish the contractor’s default or its loss before the bond can be called.

The category of bond determines how easily it can be called and how a contractor can resist a call. On-demand bonds are particularly powerful for employers, because the money can be obtained quickly, but this also makes them a source of concern for contractors who fear an unjustified call.

When a bond can be called

An employer will typically call on a bond when it alleges that the contractor has defaulted, for example by failing to complete the work or breaching the contract in a significant way. Whether the call is justified depends on the facts and on the type of bond.

For an on-demand bond, the employer may be able to obtain payment by making a conforming demand, leaving the contractor to dispute the underlying merits afterward. For a conditional bond, the employer generally has to demonstrate the default or loss first.

Resisting an unfair call

One of the biggest worries for contractors is an unfair or premature call on a bond. Where a contractor believes a call is being made without justification, there may be options to challenge it, including seeking an injunction to restrain the call in appropriate circumstances.

However, the courts approach restraint of bond calls carefully, particularly for on-demand bonds, because the commercial purpose of such bonds is to provide security that can be realised promptly. Establishing grounds to restrain a call, such as fraud or unconscionable conduct, can be demanding, which is why early and specific legal advice is so important when a call is threatened or made.

Practical points for contractors and employers

For contractors, the key is to understand the type of bond provided, the circumstances in which it can be called, and what records and arguments would support resisting an unjustified call. For employers, the focus is on calling the bond correctly and only where justified, to avoid disputes and potential liability for a wrongful call.

Because the consequences of a bond call can be significant and the law in this area is technical, both sides benefit from clear advice before acting.