Unconditional Bonds are critical to commercial transactions and construction projects. They guarantee the interests of a contractual party in the event of a default such as failure to pay or carry out obligatory performance. Nevertheless, there are many disputes over unconditional bonds involving beneficiaries who could not obtain the payment, either due to the bank dishonoring the bond agreement or litigious actions by the debtors. This Insight explores the effectiveness of Unconditional Bonds in Vietnam and offers solutions to minimize the occurrence of the bond being dishonored.
A bond is a written commitment to secure a contractual obligation in the event of a default such as a failure of to make contractual payments or otherwise comply with the contractual obligations. Typically, at the request of one party in a commercial transaction or construction contract, the other party (such as the contractor) will work with a commercial bank to obtain a bond to secure its contractual obligations under the contract. Should the contractor fail to perform one of the contractual obligations secured by the bond, the bond holder has the right to execute the bond by requesting the bank to make payment.
An unconditional bond is exactly as it sounds: a bond that allows the beneficiary to claim the money almost without any conditions (except for some minor actions such as the requirement of a written request being submitted within the valid term of the bond, etc.). For instance, if there is an alleged breach of contract, a party may use the unconditional bond to claim the money from the bank immediately in order to compensate for any damages resulting from such breach. The bank shall not make any detailed enquiry or ask the party to prove the breach of contract or delay the payment.
Thus, an unconditional bond is similar to money itself. It is commonly utilized in construction projects. For instance, the project owner usually retains approximately 5% – 10% of the contract price (i.e. the contractor is only paid 90% – 95% of the contract price) following the completion of the construction project. The retained amount is used for the potential expense of rectifying any defects that arise before the contractual date of completion or during the defects liability period after the actual completion (should the contractor fail to rectify such defects). In large construction projects, 5% – 10% of the contract price will constitute a very substantial amount and the retention of such money could affect the business cash flow of the contractor.
Hence, an unconditional bond may be used in place of an amount of money because (i) it still reserves to the owner the right to claim the money from the bank immediately if necessary, and (ii) the owner does not withhold the money of the contractor so that the business cashflow of the contractor is still available for its operations.
Problems that Arise with Unconditional Bonds
As stated above, an unconditional bond can be of great assistance to the beneficiary (project owner) in dealing with future contractual violations. It allows the beneficiary to immediately obtain the money without having to file a lawsuit or undergo time-consuming litigation proceedings. Contrary to this, the other party (contractor) is required to file a lawsuit in order to claim back the money paid on the bond. In other words, it transfers the burden of filing a lawsuit from the violated party to the violating party.
Nevertheless, an unconditional bond only works if the bank honors its promise to make the payment unconditionally under the bond. If the bank refuses to do so (e.g. to protect the alleged violating party which is usually a client of the bank), the beneficiary (project owner) will need to overcome various obstacles created by the bank and be placed in the position of fighting the bank via court proceedings.
In many countries, the beneficiary can take advantage of procedures to quickly file a lawsuit against the bank and claim the money. In addition, the bond itself should contain unambiguous language stating that the payment is to be released unconditionally should there be a default under the bond. Therefore, in these countries there is no legal tool that protects the bank and it is legally compelled to respect its commitment under the bond and protect its reputation.
However in Vietnam, both the bank and the party that obtained the bond (contractor) often work together to frustrate the purpose of an unconditional bond.
For example, Company A entered into a contract with Company B. As a guarantee for its performance, Company B obtained an unconditional bond from Bank C and provided such bond to Company A. The bond stipulated that Bank C would pay a sum up to USD700,000 on the demand of Company A without requiring Company A to supply or prove any grounds or reasons for such a demand.
Following the bond agreement, Company A requested Bank C to pay USD700,000 unconditionally due to a potential dispute with Company B. Instead of honoring the bond and conveying payment to Company A, Bank C refused the payment request on the grounds that there was no clear evidence proving the contractual breach of Company B. In this situation, Bank C dishonored its good faith commitment made to Company A to fulfill the bond obligation.
The refusal of Bank C clearly failed to comply with the agreement provided in the bond and Company A has the right to file a lawsuit with the Court to claim payment from Bank C. However, to ensure fairness in court proceedings, the court in Vietnam will not automatically rule in favor of Company A. When considering the facts and evidence in the lawsuit between Company A and Bank C, the presiding Judge will also investigate the role of Company B and invite its people to participate in the litigation proceedings as an interested party. This is because the outcome of the lawsuit would affect Company B’s liabilities to Bank C. Particularly, if a judgement is entered in favor of Company A, and Bank C is ordered to pay the money on Company B’s behalf, Bank B will be liable to indemnify the money to Bank C.
When Company B joins the proceedings, it will certainly request the Court to reject the claim of Company A for the reason that Company B did not breach the contract and, as a result, Company A has no justification to claim the money under the bond. Then, the Court will be required to consider Company B’s statement and verify the facts and evidence produced by Company B (as well as the responses of Company A) in order to determine if there was a contractual breach by Company B. This part of the litigation process favors Company B and Bank C and allows these parties to delay the payment obligation and possibly defense the claim filed by Company A. Whatever the outcome, Company A will need to wait until the Court reaches its the final conclusion regarding both the breach and the bond payment. Furthermore, even if Company A wins in the first-instance court, Company B or Bank C has the right to drag out the matter further by having the matter judicially reviewed by the Appeals Court.
This distinguishing characteristic of litigation in Vietnam results in the unconditional bond completely losing its “unconditional” status. Ideally, it should provide Company A with the right to immediately claim the money without needing to prove a breach of contract by Company B or wait until the Court concludes that such breach of contract exists. However, when Company A files a lawsuit, Company A does not possess this right and is still required to wait until the Court completes its investigation and determines whether Company B has breached the contract (which may take years in a complicated construction dispute). This is one of the unique characteristics of the Vietnamese court system, which seeks to combine all related matters into one case instead of dealing with each matter separately (i.e. the Court will attempt to consolidate both the bond dispute between Company A and Bank C and the contract dispute between Company A and Company B into one lawsuit).
The most common way to avoid difficulties is to only accept unconditional bonds issued by well-established and reputable banks. These banks value their reputation and, as a result, usually uphold their promises attached to the bonds. However, this is not an absolute solution. Completely relying on the honesty of business partners is not an advisable or stable way to do business. It is always necessary to have preventative measures in place should the bank choose to dishonor its good faith obligation under the bond.
As discussed above, in my personal experience Vietnamese Courts are not the most efficient when attempting to enforce unconditional bonds.
The most straightforward and effective solution is to add an arbitration clause to the bond agreement so that if there is any dispute between the bank and the beneficiary, such dispute will be subject to Arbitration instead of the Court. Unlike the Vietnamese Court system, Arbitration usually considers with each matter separately. For example, in the case mentioned above, if there is an arbitration clause and Company A files a claim against Bank C with the Vietnam International Arbitration Center (VIAC), VIAC may not summon Company B to join the proceedings and Company B may have to file a separate lawsuit against Company A. Because the two cases are separated, Company A can then claim the money from Bank C much earlier because Company A only needs to rely on the unconditional bond to claim the money and has no need to present arguments concerning the construction contract with Company B (as such construction contract dispute is considered to be a different matter).
Should you have any questions or wish to discuss the issues surrounding unconditional bonds, you may contact Mr. Stephen Le (email@example.com), who has over a decade of experience in commercial disputes (cross-border transactions and construction disputes in Vietnamese courts and arbitration).