A contractor receives notice that its performance guarantee is being called. The employer has, on the contractor's account, no entitlement whatever. The contractor asks the bank not to pay.

The bank pays.

Understanding why it pays is the whole of this subject, and it is the thing most parties learn at the worst possible moment.

The autonomy principle

A bank guarantee and a documentary credit are independent of the underlying contract. The bank's obligation is to pay against a demand or documents that comply with the instrument's own terms — not to investigate whether the beneficiary is right about the contract.

That independence is the entire commercial value of the instrument. A guarantee that a bank could refuse to honour whenever the parties disagreed would be worth nothing, and nobody would accept one.

So: the fact that you dispute the employer's entitlement is, by itself, not a reason for the bank to withhold payment. Nor is it a reason for a court to restrain the bank.

The fraud exception

Courts will restrain a call in narrow circumstances, principally fraud — where the demand is made fraudulently and the bank knows it, or the fraud is established clearly on the material.

Two things follow:

The standard is high. Not "the beneficiary is wrong", nor "the beneficiary is acting unreasonably", but something approaching clear evidence of fraud. Bare assertion will not do.

Move fast, and with evidence. An application to restrain must be made before payment and must be supported by material, not by argument. The window is frequently days.

A related route in some cases is an injunction against the beneficiary restraining them from making or maintaining the demand — which does not interfere with the bank's obligation and is sometimes more readily granted.

If a call is wrongful but not fraudulent, your remedy is generally a claim for damages against the beneficiary after the event, not prevention. Plan on that basis.

Types of instrument, and why it matters

On-demand guarantee. Payable on a conforming written demand, with no proof of default required. Most performance and advance payment guarantees in Pakistan are of this kind.

Conditional guarantee or surety bond. Payment depends on establishing default, which is a materially better position for the party providing it — and much rarer.

Documentary credit (LC). The bank pays against documents that comply strictly with the credit. Compliance is judged on the documents, not the goods: a perfect shipment with a discrepant presentation may not be paid, and a poor shipment with compliant documents will be. See starting to import or export and exporting textiles from Pakistan.

Standby credit, which functions like a guarantee.

Know which one you have signed. Parties routinely describe an on-demand instrument as though it were conditional.

Limiting exposure when you give one

Negotiate these before issue, because afterwards you have no leverage:

  • Amount — proportionate to the actual risk, not the contract value by habit
  • Expiry, with a definite date, and resistance to open-ended "until the employer confirms" wording
  • Reduction as performance milestones are achieved
  • Return of the original on expiry, and release of your counter-security
  • Conditions for calling — even in an on-demand instrument, requiring the demand to state the nature of the breach adds a small but real discipline
  • Extend or pay clauses, which are how guarantees become perpetual: resist them, or cap the number of extensions

Remember the counter-indemnity you give your bank. When the guarantee is called, the bank debits you and looks to your security. Your dispute is then with the beneficiary, from a position of having already paid.

When you are the beneficiary

Hold a guarantee that actually works: an on-demand instrument from a bank of substance, with an expiry that outlasts your risk, and wording you can comply with.

Diarise the expiry. Guarantees lapse unclaimed with striking regularity.

Call only where you have a genuine entitlement. A call made without any honest belief in entitlement exposes you to a damages claim and, in a bad case, to worse.

Practical advice

Read the instrument before you sign the contract that requires it. Keep the original and know where it is. Diarise expiry dates on both sides. Where a call is threatened, take advice within days — not after the payment has been made. And budget on the basis that if the instrument is on-demand, it will be paid.

How the firm can help

We draft and negotiate guarantee and credit wording, advise on the exposure a proposed instrument actually creates, and act urgently where a call is threatened — including applications to restrain a fraudulent call or to restrain a beneficiary from demanding.

We also act in the claims that follow a wrongful call, and in disputes about compliance of documents under letters of credit, for both banks and commercial parties. See banking and finance.

If a guarantee is about to be called, this is measured in days. Telephone the chambers — (021) 3263 7006.