On Demand Guarantees in Construction Projects
What does an on demand guarantee mean in practice, and what are your rights if the guarantor refuses payment? A recent judgment from the Borgarting Court of Appeal sheds light on how on demand guarantees in construction contracts should be interpreted.
In this article, we provide the key information you need to understand this type of unconditional bank guarantee – and what it may mean for your construction projects.
On Demand Guarantees in Construction Projects – What Does an “On Demand” Guarantee Mean in Practice?
What does an on demand guarantee mean in practice, and what are your rights if the guarantor refuses payment? A recent judgment from the Borgarting Court of Appeal sheds light on how on demand guarantees in construction contracts should be interpreted.
In this article, we explain what an on-demand guarantee is, how such guarantees are used in construction contracts, and what the new court decision means for you as a developer, contractor, or guarantor. We provide the key information you need to understand this type of unconditional bank guarantee – and what it may mean for your construction projects.
What Is an On Demand Guarantee?
An on demand guarantee is a form of security in which the guarantor – typically a bank or an insurance company – undertakes to pay the beneficiary upon demand. These guarantees operate on the principle of “pay first, argue later”. Generally, there is no need to document that there has been a breach of contract, and the guarantee is, as a starting point, independent of any underlying disputes between the parties to the underlying contract.
Unlike a surety guarantee, where the guarantor is only obliged to pay upon proof of breach, an on demand guarantee is a robust payment instrument that provides the creditor with assurance of swift payment – even where there may be an ongoing dispute regarding the main contract.
Typical Uses of On Demand Guarantees
On demand guarantees are frequently used in construction and supply contracts, particularly in the following contexts:
- Security for advance payments: The contractor or supplier receives payment in advance, while the employer or buyer obtains a guarantee for the advance amount.
- Security for contractual performance: The parties obtain a guarantee covering costs in the event the other party fails to perform as agreed.
- International transactions: Where there is uncertainty regarding the other party’s creditworthiness or jurisdiction.
What Happens if the Guarantor Refuses Payment Under an On Demand Guarantee? A Landmark Judgment from the Court of Appeal
What happens when a guarantor refuses to pay upon receipt of a demand under an on demand guarantee, arguing that the guarantee is not meant not cover the particular claim? This was the central issue in a recent case before the Borgarting Court of Appeal, where Brækhus Law Firm represented a foreign design and build contractor who won in all instances. The judgment provides clarification at the intersection of construction law and guarantee law, an area that has been little explored in Norwegian case law to date.
The Judgment Clarifies the Scope in Practice
In the judgment (LB-2024-6148), the Court of Appeal considered a case where a building developer had provided an on demand guarantee in connection with the delivery and installation of modular units for a major residential development in Jessheim. The guarantee covered the employer’s “obligations during the contract period”.
When the contractor submitted a demand for payment under the guarantee, the guarantor rejected the claim, arguing that the guarantee only covered specific instalments in the payment schedule – specifically, production of the modules abroad and transportation to the construction site. Both the District Court and the Court of Appeal disagreed, and the Supreme Court refused leave to appeal.
The Court of Appeal held that this was a pure on demand guarantee, and the guarantor’s argument that the guarantee should be interpreted restrictively in light of the underlying contract terms did not succeed. The wording of the guarantee document was clear and covered all “contractual obligations” during the project period. It was not permissible to imply a narrower scope based on what the parties might have intended – especially where the guarantee had been provided using standard wording and without reservations.
The contractor had submitted a formal demand within the guarantee period and within the monetary limits. The guarantor also invoked the so-called “fraud exception” rule and also argued that the contract vas void under Section 33 of the Norwegian Contracts Act, but the Court of Appeal rejected all objections, and the contractor succeeded in full.
You can read the judgment here (in Norwegian): Borgarting lagmannsrett – Dom: LB-2024-6148 – Lovdata
What Key Clarifications Does the Judgment Provide for On Demand Guarantees?
The judgment is of fundamental importance in that it:
- Confirms that Norwegian courts follow the international understanding of on demand guarantees, whereby such guarantees are to be interpreted independently of underlying contractual disputes.
- Establishes that the wording of the guarantee document is decisive, and that it requires significant justification to construe the guarantee as having a narrower scope through subsequent interpretation.
- Demonstrates that invoking the “fraud exception” rule is not straightforward – it is for the guarantor to prove that the demand is manifestly unfounded, a high threshold to meet.
- Provides certainty that beneficiaries of on demand guarantees can rely on the wording of the guarantee as written, without fear that it will later be undermined through interpretation and argument.
This is the first time a Norwegian court has addressed the scope of an on demand guarantee in a substantial dispute, and the judgment will likely serve as an important precedent for future cases concerning on demand guarantees.
What Does This Mean for You?
If you have a claim under an on demand guarantee, this judgment makes it easier to obtain payment swiftly, without becoming entangled in protracted arguments over the underlying contract.
If you have provided, or are considering providing, an on demand guarantee, it is important to be aware that the wording of the guarantee document is decisive. It is the text of the guarantee that determines the guarantor’s payment obligations “on demand”, and you, as the party requesting the guarantee, will be liable for reimbursement. It is therefore vital to ensure that there is no discrepancy between what you intend the guarantee to cover and what is actually stated in the document.
For both parties in a contractual relationship, the judgment highlights the importance of precise drafting and careful risk assessment at the contract formation stage.
Practical Advice
- Read the guarantee wording carefully: The wording is decisive – not what the parties later claim was their intention.
- Assess the risk: On demand guarantees provide strong security for one party – and corresponding exposure for the other.
- Document any limitations in writing: If the guarantee is to have a limited scope, this must be clearly stated in the document.
- Respond promptly if you dispute a claim: The guarantor must immediately clarify its position if it considers there are no grounds for payment; failure to do so may weaken the guarantor’s position.
Read more: Brækhus Doubles the size of its Construction Team
Need Assistance?
Brækhus Law Firm has extensive experience in advising and litigating in the fields of construction, guarantee law, and other contractual matters. We assist both beneficiaries and guarantors with strategic advice, negotiation, and litigation in both national and international contexts.
Feel free to contact us for an initial assessment without obligation.
