Guarantee or trap: How contracting authorities abuse performance guarantees in public procurement

A performance bond in public procurement is a sum of money or guarantee provided by the successful tenderer to the contracting authority as ‘assurance’ that they will fulfil their obligations. The Law of Ukraine ‘On Public Procurement’ limits the amount of such a security (no more than 5 per cent of the contract price, and for works — up to 5 per cent; the new version of the law provides for up to 10 per cent) and specifies the circumstances in which the security is to be returned to the supplier. In accordance with Part 2 of Article 27 of the current Law, the contracting authority shall return the contract performance security in the following cases: 1) full performance of the contract by the successful tenderer; 2) following a court ruling ordering the return of the security, if the tender results or the contract itself are declared invalid; 3) in other cases provided for in Article 43 of the Law (termination of the contract under certain circumstances, etc.); 4) on other grounds specified in the contract, but no later than 5 banking days after the relevant circumstances arise. In other words, once the contract has been duly completed, the customer is obliged to promptly return the guarantee funds to the supplier.

In practice, this rule is sometimes breached. The most contentious ground is precisely the first one — full performance of the contract. Customers sometimes interpret this in their favour, claiming that any breach of the contract’s terms (for example, late delivery or failure to meet deadlines) entitles them to retain the security. This has given rise to a number of legal disputes, and case law has repeatedly sided with bona fide contractors. According to the legal position of the Supreme Court, the only ground for withholding the security can be the supplier’s failure to fulfil its obligations (i.e. a complete breach of the contract), and not improper performance such as failure to meet deadlines or other terms. In other words, if the supplier has, after all, performed the contract (even with certain shortcomings that did not prevent the contract’s purpose from being achieved), the customer has no formal grounds for retaining the security. In such a case, the customer is obliged to return the guarantee funds received.

A recent case concerning an equipment supply contract is illustrative. The supplier company delivered the goods, albeit with a slight delay. The customer — a state-owned enterprise — drew upon the bank guarantee provided for an amount exceeding 800,000 UAH and received these funds from the guaranteeing bank on first demand, citing a breach of the delivery deadlines. The supplier was forced to bring a claim before the court seeking the return of the security unjustifiably acquired by the customer. The courts established that the goods had been delivered to the customer in full, and that the delay did not prevent acceptance of performance. In accordance with the terms of the contract and the law, the customer was required to return the security within five days of the contract being performed; the only grounds for non-return could have been complete non-performance of the contract, rather than late performance. The Supreme Court, in its ruling in case No. 910/12114/23, upheld this position, noting that the legal relations in this case are governed not only by the Civil Code of Ukraine and the Commercial Code of Ukraine, but also by a special law—the Law of Ukraine ‘On Public Procurement’—Part 2 of Article 27 of which stipulates that the contracting authority shall return the performance guarantee for the procurement contract after the successful tenderer in the procurement procedure/simplified procurement procedure has performed the procurement contract, no later than within five banking days from the date on which the specified circumstances arise. Consequently, the contracting authority is obliged to return the amount of the guarantee to the supplier.

A different situation arises when the supplier has indeed failed to perform the contract. In the event of complete non-performance of obligations (for example, the goods have not been delivered at all), the contracting authority is entitled to retain the security for its own benefit.

Consequently, in the event of actual non-performance of the contract, the supplier forfeits the security deposit, and the courts uphold the customer’s right to these funds. Conversely, in the event of improper but nevertheless actual performance (such as a breach of deadlines whilst the work was fully completed), the court sides with the contractor and regards the funds received by the customer as having been acquired on grounds that subsequently ceased to exist, and therefore as constituting unjust enrichment, which is subject to restitution. This approach has already been confirmed on numerous occasions by the Supreme Court (Case No. 910/11352/24 and Case No. 910/18875/23).

Particular attention should be paid to bank guarantees as the most common form of security in public procurement. A guarantee is, in essence, an independent undertaking by a bank to pay the contracting authority a specified sum in the event of the supplier’s failure to perform the contract. It may be issued in the form of an electronic document and is usually irrevocable and unconditional in public procurement. This means that the bank (the guarantor) will pay the funds upon the first written demand from the beneficiary (the contracting authority) without any objections. The guarantor is not authorised to determine whether the supplier has actually breached the contract — it merely checks the formal documents and is then obliged to transfer the funds to the customer. At the same time, the supplier (as the party responsible for performance) cannot raise any objections to the customer’s claims against the bank. In other words, even if the supplier believes there were no grounds for calling on the guarantee, they will be unable to stop the payment. The funds will be debited, and only afterwards will the supplier be able to seek their return through the courts. This arrangement provides the customer with maximum protection — they receive the money quickly, whilst any disputes are resolved after the fact. Unfortunately, this is sometimes abused: some unscrupulous customers are tempted by the opportunity to quickly boost their budget at the expense of the guarantee and occasionally make a claim to the bank even in the absence of a clear ‘guarantee event’.

Read the full article on the “Yurydychna Gazeta” website: here.