Performance bond and guarantee litigation is a recurring feature of major construction projects and forms a critical part of modern Construction & Projects Disputes. Because performance bonds provide financial security for employers in the event of contractor default, delay, or non-performance, disputes often emerge when employers attempt to call the bond and contractors seek to restrain calls they view as unlawful or abusive. Understanding how these instruments operate, the circumstances in which they can be called, and the legal strategies available to both employers and contractors is essential for navigating high-stakes construction conflicts in the UAE and internationally.
Performance bonds are financial instruments issued by banks or insurers to secure a contractor’s obligations under a construction contract. They typically take the form of on-demand (unconditional) bonds, conditional bonds, or parent company guarantees. On-demand bonds require the issuing bank to pay upon the employer’s written demand, regardless of the underlying dispute, while conditional bonds require proof of breach or non-performance before payment. Parent company guarantees provide an additional layer of security by placing responsibility on the contractor’s corporate group. In UAE construction markets, on-demand bonds are widely preferred by employers, but they also generate the most litigation because of their strict and often controversial enforceability.
Disputes commonly arise around the timing, legitimacy, and purpose of a bond call. Employers may seek to call the bond in response to perceived contractor delay, defective work, abandonment, or termination, whereas contractors may argue that the employer’s call is premature, disproportionate, or motivated by leverage rather than genuine loss. Typical flashpoints include calls made while extension-of-time claims are pending, calls during ongoing negotiations or dispute resolution processes, and calls made after alleged employer breaches. Because bond calls can significantly affect contractor liquidity, banking relationships, and reputation, contractors often respond with urgent applications to restrain the bank from making payment.
On-demand bonds are akin to documentary credits: the bank’s obligation is largely independent from the underlying construction contract. Provided the employer’s demand complies with the terms of the bond, the bank must pay without investigating the merits of the underlying dispute. Courts and tribunals are generally reluctant to interfere with on-demand bonds, recognising their commercial value as reliable security. Intervention is usually limited to exceptional circumstances such as clear fraud or serious abuse of rights.
Conditional bonds require the employer to demonstrate breach, default, or quantified loss before payment is made. Litigation in this context often focuses on whether contractual preconditions to a valid call have been satisfied, such as prior notices, certifications, or determinations, and whether the employer has substantiated its loss. Conditional bonds therefore mirror the underlying contractual dispute more closely and involve deeper scrutiny of performance issues.
Across many jurisdictions, including those influencing UAE practice, courts will only restrain bond calls in narrow circumstances. Two commonly invoked grounds are fraud and abuse of rights or bad faith.
Fraud arises where the employer knowingly makes a demand under the bond without any honest belief in the contractor’s default or loss. The threshold is extremely high: contractors must produce clear and compelling evidence that the demand is deliberately dishonest, not simply mistaken or disputed. Because fraud allegations are serious and difficult to prove at an interim stage, this ground is rarely successful but remains an important safeguard against manifestly abusive calls.
In civil law jurisdictions, including the UAE, courts may intervene where an employer’s call constitutes an abuse of contractual rights or a breach of the duty of good faith. Examples include calling the bond despite the employer being the true cause of delay, calling the bond in direct contradiction to recent approvals or certifications of satisfactory performance, or using the bond purely as tactical leverage in negotiations rather than as genuine compensation for loss. While the bar remains high, abuse-of-rights arguments offer contractors a broader pathway to relief than fraud alone.
The wording of the bond and related contract provisions is central to later disputes. Ambiguous language on whether the bond is on-demand or conditional, unclear references to underlying obligations, or inconsistent cross-references to the construction contract can all create uncertainty. Well-structured instruments should clearly state whether the bank’s obligation is independent, set out the documentary requirements for a valid demand, and align with the risk allocation agreed in the main contract. Parties should also consider caps on aggregate liability, expiry dates linked to completion and defects liability milestones, and procedures for reduction or release of the bond as works progress.
Employers rely on performance bonds as a key risk management tool and must exercise their rights carefully to avoid successful challenges. Best practices include ensuring strict compliance with any contractual preconditions before calling the bond, documenting the factual basis for the call, and aligning the timing of the demand with project milestones, engineer certifications, or termination notices where applicable. Employers should also avoid making demands that materially exceed plausible loss or that can be portrayed as punitive, as such conduct may support allegations of abuse of rights. Clear internal decision-making records and correspondence help defend the legitimacy of the call if challenged in court or arbitration.
Contractors can mitigate risk at both the contracting and project execution stages. At the drafting stage, they should negotiate caps on bond value, clear release triggers, and language that restricts calls in the absence of specific breach findings or determinations. During the project, they should maintain rigorous records of instructions, delays, and performance certifications to counter any assertion of default. When faced with a potential call, contractors may seek urgent injunctive relief, relying on arguments of fraud, abuse of rights, or non-compliance with contractual preconditions. Early engagement with legal and technical experts is critical, as courts often act quickly on injunction applications relating to bank guarantees.
Performance bond litigation rarely occurs in isolation. It often runs in parallel with wider disputes on delay, defects, variations, or termination. Even where courts decline to restrain a bond call, contractors may still pursue recovery of amounts paid through arbitration or litigation on the merits of the underlying contract. Conversely, employers who call the bond may subsequently face counterclaims for wrongful call if tribunals later find no contractual default. This interaction means bond strategy must be aligned with the broader dispute resolution plan, including FIDIC mechanisms, expert determinations, and arbitration proceedings.
Performance bond and guarantee litigation sits at the intersection of banking law, construction law, and commercial strategy. For employers, performance bonds provide essential security that underpins large-scale project delivery; for contractors, they represent a concentrated financial and reputational risk that must be managed carefully. By drafting clear bond and guarantee provisions, respecting contractual preconditions, and understanding the narrow yet important grounds for court intervention, parties can reduce uncertainty, protect their positions, and handle performance security disputes in a structured and commercially disciplined manner.
