Performance guarantee forfeiture for breach of contract is lawful unless excessive or disproportionate: SC

ISLAMABAD, Jul 03 (APP): The Supreme Court of Pakistan has ruled that the forfeiture of a performance guarantee for breach of contract is legally permissible, holding that under Section 74 of the Contract Act, 1872, courts may intervene only where the amount forfeited is unreasonable, disproportionate or amounts to a penalty.

In a detailed judgment, a three-member bench comprising Chief Justice Yahya Afridi, Justice Naeem Akhtar Afghan and Justice Shakeel Ahmad decided appeals arising out of a dispute between the Trading Corporation of Pakistan (TCP) and M/s Abdullah Mezroei Metal Trading Company over a contract for the import of urea.

The court observed that performance guarantees are intended to ensure the timely and complete fulfilment of contractual obligations. Where a party fails to perform within the stipulated period or breaches the terms of the contract, forfeiture of the guarantee may be justified. However, courts retain the authority to examine whether the amount forfeited is reasonable, though this does not mean that contractual terms should be disregarded in every case.

The judgment noted that TCP invited tenders on August 18, 2005, for the import of 50,000 metric tonnes of urea. The foreign company’s bid of 225 US dollars per metric tonne was accepted. Under the agreement, the supplier was required to furnish a performance guarantee equivalent to three per cent of the contract value, while TCP was to establish a letter of credit (LC). The contract also required all three consignments of urea to arrive at Karachi within the stipulated period, making time the essence of the agreement.

The court observed that although there was some initial delay in operationalising the LC, TCP subsequently made the necessary amendments and granted the supplier additional time to deliver the urea. Despite the extension, the company failed to deliver even a single consignment.

According to the judgment, the supplier later attributed its failure to perform to rising global urea prices and shortages in the international market, seeking a further extension of 30 days. TCP rejected the request, cancelled the letter of credit on January 2, 2006, and forfeited the performance guarantee.

The Supreme Court held that the contract expressly authorised TCP to forfeit the performance guarantee if the supplier failed to deliver the goods within the agreed timeframe or otherwise breached the agreement. It further noted that the contract specifically provided that granting an extension of time would not prejudice TCP’s right to invoke the guarantee.

The bench found that the record clearly established the supplier’s failure to fulfil its contractual obligations and that all conditions required for the forfeiture of the performance guarantee had been satisfied.

Emphasising the importance of commercial certainty, the Supreme Court held that courts should respect the terms freely negotiated by parties to major commercial agreements, as certainty in contractual enforcement forms the foundation of business confidence.