Supply & Performance Agreements 

What are performance and supply guarantees?

Performance or supply guarantees / agreements are a common form of ensuring that parties within a transaction uphold their obligations and meet certain requirements. Whether it be the supply of goods or reaching a certain degree of performance to complete a task, a guarantee outlines the requirements and provides insurance to the party obtaining the goods or service. This is usually enforced by holding funds or assets within a third parties accounts until the guarantee expires or is claimed.

What forms can these guarantees take?

  1. Bank Guarantee; A bank guarantee is a document provided to you by your bank or financial institution which outlines who the parties are and the sum of capital that has been put forward to cover the agreed amount of security. Banks will hold the funds in a Term deposit or a prescribed account and will not release these funds until the original bank guarantee or release letter has been provided by the favouree. Some banks will provide lending to cover these costs however others will only take funds provided by the guarantor.
  1. Insurance Bond; These are usually unconditional performance bonds issued by insurance companies. The same issues that arise with bank guarantees arise with these documents, however, the credit risk lies with an insurer, rather than a bank.
  1. Letter(‘s) of Credit; A letter of credit usually refers to an arrangement with a bank or financial institution in which the bank provides a guarantee that the funds are available or approved should the requirement to fund the beneficiary occur. There is a range of different types of credits including confirmed credits, sight credits, revolving credits and standby credits. Letters of credit have been widely utilised when dealing with international trade, however with the rise of electronic banking other forms of guarantee have become more popular.

  What risks are involved with Performance and Supply Guarantees?

Credit Risk: Should funds be put forward as security for the performance or supply of goods and services, the risk of loosing these funds are very real as the bank has no obligation to hold or notify the owners should the beneficiary seek to claim these funds. Depending on the agreement, there can also be unlimited financial recourse meaning that; Should the losses amount by the failure to perform or supply exceed the security amount, further financial recourse can be taken.

Corporate benefit: How does the giving of the performance guarantee benefit the guarantor? A guarantee that does not benefit the company, and therefore breaches a director’s fiduciary duty, may be voidable by the company. This is less of an issue where a parent guarantees the obligations of a subsidiary, however, it may be harder to show corporate benefit if a subsidiary is guaranteeing the obligations of its parent (although section 187 of the Corporations Act may provide some assistance for 100 per cent owned subsidiaries).

Enforcement Risk: Should the agreement or guarantee need to be enforced you will need to ensure that the entity in which the agreement has been made with is able to be held accountable under the jurisdiction in which the agreement has been made. For example, is the entity that the your making agreements with registered in Australia or a country in which you can seek legal recourse.

Performance risk: Consideration needs to be given to whether the guarantor can perform the obligation it is guaranteeing. For example, in Queensland, if the principal under a building contract insisted that the holding company of the contractor complete construction, it may find the parent does not have the requisite license to do so and performance by that company (or even agreeing to perform that work) may be illegal.

In conclusion, it is always recommended to seek legal and financial advice prior to entering into such agreements. Know your counterpart; who is the agreement being made with? Can recourse be made should there be a breach of agreement?

BlueKey Lawyers can assist you in working your way through such agreements and ensuring that your legal and financial risks are mitigated.

Call Now