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Given the significant risks inherent in large-scale construction projects, performance bonds are commonly used to guarantee performance and reinforce trust between contracting parties. In Bahrain and across the wider region, employers commonly rely on performance bonds, typically comprising 5-10% of the total contract value, as one of the means to safeguard against financial loss arising from delays, non-performance, or unforeseen disruptions attributable to the contractor. This article considers the regulation and enforcement of performance bonds under Bahraini law and outlines the legal remedies and practical considerations relevant to their use in construction contracts.
Performance Bonds
Performance bonds (or letters of guarantee) are defined under Article 331 of Decree Law No. 7/1987 issuing the Law of Commerce (the "Law of Commerce") as an undertaking by a bank, at the request of one of its customers (typically the contractor), to pay a specified or determinable sum to the beneficiary (typically the employer) upon demand within the period stated in the instrument.
As discussed further under Legal Framework and Enforcement below, performance bonds are autonomous in nature, creating a separate and distinct legal relationship between the bank and employer, independent of the contractual terms governing the relationship between the contractor and employer. Their commercial purpose is to provide the employer with a secure and readily available source of payment in the event of non-performance, without the need to litigate the merits of the underlying contract, which can be a time-consuming and financially burdensome process.
Legal Framework and Enforcement
Performance bonds are specifically regulated under Articles 331-336 of the Law of Commerce, and more broadly governed by Articles 128 and 129 of the Civil Code, which provide that contracts are binding according to their terms and must be performed in good faith.
Article 334 of the Law of Commerce provides that the issuing bank may not refuse payment to the beneficiary on the basis of objections arising from its relationship with the applicant or from disputes between the applicant and the beneficiary. Additionally, Article 335(1) provides that the bank is discharged from liability if no demand is made within the validity period of the guarantee, unless that period is expressly renewed.
Taken together, the above provisions establish the principle of autonomy underpinning performance bonds under Bahraini law. The bank's obligation to honour the bond exists independently of the underlying contract between the applicant and the beneficiary. In practice, this means that the bank cannot rely on defences available to the contractor, and its commitment to honour the bond remains valid even if the agreement between the parties is void, rescinded, or terminated, so long as the performance bond remains in force. Similarly, the bank may not refuse payment on grounds arising from its relationship with the contractor. The bank's liability towards the employer is extinguished only if no demand for payment is received within the validity period of the bond.
That said, the bank's obligation to honour a call is not without limitation and remains subject to compliance with the bond's express terms. In Challenge No. 6 J.Y. 2020, the Bahraini Court of Cassation confirmed that "The effect of issuing a letter of guarantee and notifying the beneficiary thereof is that the beneficiary acquires a direct right against the bank. Since this right arises from the letter itself, it is governed by the terms and conditions set out therein, and the beneficiary must comply with those terms in order to benefit from the guarantee. Accordingly, if the letter of guarantee sets a maximum amount or requires that the beneficiary's demand be accompanied by certain documents, the beneficiary must adhere to those requirements, otherwise, the bank may justifiably refuse to fulfil its obligation under the guarantee.
Available Legal Remedies
Where a contractor believes that an employer's call on a performance bond is unjustified or made in bad faith, the avenues for relief under Bahraini law are limited to (i) seeking a provisional attachment over the bond amount prior to its encashment or (ii) pursuing a claim for compensation equivalent to the sum paid out by the issuing bank.
In practice, it is rare for Bahraini courts to grant an attachment order over the amount secured by a performance bond, unless there is compelling evidence that it may be called in bad faith. The prevailing judicial approach favours allowing the issuing bank to proceed with payment in accordance with the bond's terms. Disputes relating to extensions of time, payment defaults, variations, or the engineer's determinations are considered substantive contractual matters that must be resolved under the building contract itself, and often, do not constitute sufficient grounds to restrain a call on the bond.
In effect, contractors are left with limited immediate recourse and are generally required to pursue their substantive entitlements through the building contract, seeking recovery or adjustment once the dispute has been determined, and accounting for any sums called under the bond, together with any resulting financial losses.
Practical Considerations
While performance bonds serve to protect employers from the financial consequences of contractor default, their wrongful encashment can have significant financial repercussions for contractors. In such circumstances, the contractor's only recourse is to litigate the underlying dispute and seek compensation, an approach that is often costly, time-consuming, and can be commercially disruptive.
To safeguard both parties' interests, it is considered best practice to include conditions under the performance bond requiring the employer to provide supporting documentation from an independent third party (such as the appointed engineer) confirming the breach, detailing the alleged defaults and associated losses. Contractors, in turn, should ensure strict compliance with applicable legal notice requirements, proactively pursue extensions of time and related claims, and maintain accurate project records to protect their financial position.
Concluding Remarks
In a market where timely completion and financial certainty are paramount, performance bonds remain an essential risk management tool. Employers should ensure that any call on a bond is proportionate, justified, and procedurally sound. Contractors, on the other hand, can best protect their position through diligent contract administration and comprehensive record-keeping. A balanced and transparent approach not only reduces the likelihood of contentious calls but also fosters stronger commercial relationships and ensures more predictable project outcomes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
