In Pacific Atlantic Pipeline Construction Ltd. v. Coastal Gaslink Pipeline Ltd., 2024 ABCA 74 (Coastal Gaslink) the Alberta Court of Appeal ("ABCA") upheld a decision denying an application for an injunction restraining the Respondent from drawing on an irrevocable standby letter of credit ("SLOC") pending the conclusion of arbitration proceedings between the parties.
What is a SLOC and why are they important?
A SLOC is a form of security pursuant to which an issuer (typically a bank) guarantees payment to a third-party beneficiary in the event that the issuer's customer (the applicant) defaults under its agreement with the beneficiary. SLOCs typically entitle a beneficiary to demand immediate payment from the issuer if it has a bona fide belief that the applicant has defaulted under its agreement or otherwise breached the terms of the SLOC.1
As stated by Justice Whitling, SLOCs play a significant role in the Canadian construction industry and remain the predominant form of security for international construction projects.2 They are often relied on in large construction projects where an owner seeks to secure a contractor's obligation to perform under the contract.
The fundamental principle governing SLOCs – and the characteristic that gives them their utility – is that they operate as autonomous instruments that are independent from and generally unaffected by disputes about performance of the underlying contract between the applicant and beneficiary. SLOCs therefore provide beneficiaries with a guaranteed means of obtaining timely payment by presenting "drawdown documents" to the issuer confirming the beneficiary's bona fide belief that the beneficiary is entitled to demand payment pursuant to the SLOC's terms. In Canada, the only recognized exception to this principle is fraud. If a beneficiary fraudulently asserts entitlement under a SLOC, an issuer is not required to honour the beneficiary's request, and an applicant can apply to the court for injunctive relief.3
Background
In Coastal Gaslink, the respondent, Coastal Gaslink Limited Partnership ("CGL"), hired the applicant, Pacific Atlantic Pipeline Construction Ltd. ("PAPC"), to construct a portion of a large pipeline in British Columbia. The construction contract required PAPC to provide CGL, as beneficiary, with a SLOC in the amount of C$117,162,384 to guarantee PAPC's performance under the construction contract.4 The project experienced significant challenges due to the COVID-19 pandemic and various protests, and PAPC failed to complete some of its contractually assigned work.5 As a result, CGL terminated the contract. PAPC in turn commenced arbitration proceedings, seeking damages for wrongful termination.6
Following an unsuccessful mediation, the parties met for negotiations in June 2022, during which PAPC sought assurances from CGL that it would not draw on the SLOC. When pressed on this issue, a CGL representative stated that "CGL is not in the habit of putting its contractors out of business" and indicated that CGL did not, at that time, have any intention of drawing on the SLOC.7 In October 2023, approximately two weeks before the parties were required to exchange their witness statements and expert reports for arbitration, CGL executed drawdown documents and demanded payment under the SLOC.8 PAPC brought an application seeking to restrain CGL from drawing on the SLOC until the arbitration had been resolved.
PAPC made three arguments in support of its application for injunctive relief:
- The parties had reached a verbal forbearance agreement at the June 2022 meeting pursuant to which CGL agreed not to draw on the SLOC pending completion of the arbitration;
- CGL breached its duty of honest contractual performance in drawing on the SLOC after stating that it did not intend to do so; and,
- CGL should not be entitled to draw on the SLOC for any purpose other than paying for completion of the project.
Justice Whitling denied PAPC's application but granted an interim injunction restraining CGL from drawing on the SLOC for approximately two weeks – giving PAPC time to appeal. On appeal, the ABCA upheld Justice Whitling's decision and allowed CGL to draw on the SLOC.
What is the standard of proof for a verbal forbearance agreement?
PAPC argued that the comments made by the CGL representative at the June 2022 meeting amounted to a verbal contract pursuant to which CGL agreed not to draw on the SLOC until the arbitration had concluded. Justice Whitling was prepared to assume (without deciding) that a beneficiary could be enjoined from drawing on a SLOC on the basis of a contractual obligation.9 As is the case with the fraud exception, Justice Whitling held that the relevant standard at the first stage of the tri-partite test for an injunction was whether the applicant had a "strong prima facie case" that a contractual obligation preventing the beneficiary from drawing on the SLOC existed.10
Justice Whitling held that PAPC did not have a strong prima facie case that CGL had explicitly agreed to refrain from drawing on the SLOC.11
On appeal, PAPC argued that Justice Whitling was incorrect to require it to meet the "strong prima facie case" threshold and should have instead relied on the usual standard for injunctions – whether the applicant's case presented a "serious question to be tried".12 In dismissing the appeal, the ABCA held that the stricter standard was appropriate and necessary to prevent interference with the independence and utility of SLOCs.
Did CGL breach its duty of honest contractual performance?
PAPC's second argument was that CGL had breached its duties of honest contractual performance and good faith. PAPC argued that CGL had knowingly deceived and misled it at the June 2022 meeting and should therefore be restrained from drawing on the SLOC. In dismissing PAPC's arguments, Justice Whitling held that there was no strong prima facie evidence that CGL intentionally misled or deceived PAPC into believing that it would not draw on the SLOC. Notably, he also held that CGL was not responsible for correcting PAPC's mistaken belief, even if it was aware of such belief.13
Justice Whitling held that CGL was within its rights to attempt to leverage its rights under the SLOC into a negotiated settlement at arbitration – the duty of honest performance "does not prohibit a contracting party from pursuing their individual self-interest, even if doing so may cause loss to another party".14
On appeal, PAPC argued that Justice Whitling had applied the incorrect test by concluding that the duty of honest performance would only be breached where one party intentionally deceived or misled another. PAPC argued that the correct test was whether a party knowingly misled or deceived another and that CGL had knowingly misled it into believing that the SLOC would remain untouched. The ABCA dismissed PAPC's argument and held that Justice Whitling had properly applied the test as articulated in Bhasin and Callow and that nothing turned on his use of the word "intentionally" instead of "knowingly".15
Should reliance on a SLOC be restricted to obtaining funds to complete a project?
PAPC asserted that the purpose of a SLOC is to secure performance obligations.16 CGL had already hired other contractors to perform PAPC's work, and, by the time the motion was heard in December 2023 the pipeline project was substantially complete.17 PAPC therefore argued that CGL had drawn on the SLOC for an improper purpose, since the purposes identified in the construction contract were limited to paying for the completion of the project work, which was already substantially complete.18
PAPC's argument was summarily rejected both by Justice Whitling and the ABCA. Given that there were no allegations of fraud, the only "guardrails" to CGL's ability to draw on the SLOC were the conditions in the SLOC.19 The language of the SLOC was clear that the SLOC was on demand20and CGL could make a demand if it considered that PAPC failed to perform its contractual obligations.21
Key Takeaways
Coastal Gaslink signals that Alberta courts are prepared to protect the efficacy of SLOCs and will not readily interfere with beneficiaries who seek to draw on them. Key takeaways include:
- If and when Canadian courts determine that a contractual obligation may be grounds for an injunction to prevent a party from drawing on a SLOC, the party seeking an injunction will likely have to prove they have a "strong prima facie case" that the beneficiary is contractually prohibited from executing a drawdown;
- the duty of honest performance does not prohibit a beneficiary from leveraging its rights under a SLOC into a negotiated settlement with an applicant; and
- the only pre-conditions to drawing on a SLOC are those listed in the SLOC itself. So long as those conditions are satisfied, the beneficiary's intentions with respect to the use of the funds (including to pay for the completion of a project) are irrelevant.
Footnotes
1. Pacific Atlantic Pipeline Construction Ltd v Coastal Gaslink Pipeline Ltd, 2023 ABKB 736, (Coastal Gaslink – KB) at para 69.
2. Coastal Gaslink – KB at para 38.
3. Coastal Gaslink – KB at para 41, referring to Bank of Nova Scotia v.Angelica-Whitewear Ltd., [1987] 1 SCR 59 at para 11.
4. Coastal Gaslink – KB at paras 1 and 7.
5. Coastal Gaslink – KB at paras 9-11.
6. Pacific Atlantic Pipeline Construction Ltd. v. Coastal Gaslink Pipeline Ltd., 2024 ABCA 74 (Coastal Gaslink) at para 1.
7. Coastal Gaslink – KB at paras 14, 56.
8. Coastal Gaslink – KB at paras 32-33.
9. Coastal Gaslink – KB at para 4.
10. Coastal Gaslink – KB at para 48.
11. Coastal Gaslink – KB at para 62.
12. Coastal Gaslink at para 5 – referring to RJR-MacDonald Inc. v. Canada (Attorney General),[1994] 1 SCR 311.
13. Coastal Gaslink – KB at paras 67-68.
14. Coastal Gaslink – KB at para 66.
15. Coastal Gaslink at para 19.
16. Coastal Gaslink at para 13.
17. Coastal Gaslink – KB at para 63.
18. Coastal Gaslink at para 13..
19. Coastal Gaslink – KB at para 69.
20. Coastal Gaslink – KB at para 7.
21. Coastal Gaslink - KB at para 69.
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