An "on demand" performance bond imposes a primary obligation on the issuer (normally a bank) to pay in circumstances where the principal has failed to perform the contract and the beneficiary sends it a written demand. There is no need for the beneficiary to first sue the defaulting party and to prove a breach of contract.
The English courts are traditionally reluctant to grant a principal an injunction to restrain the beneficiary from making a demand. It has been established that an injunction may be granted where there is a fraudulent demand (and the court is satisfied that the issuer knows that the demand is fraudulent). In a recent case, though, a principal sought to prevent a beneficiary from seeking payment under a bond in circumstances where no fraud was alleged.
Simon Carves Ltd v Ensus UK Ltd
Simon Carves Ltd ("SCL") was a contractor employed by Ensus UK Ltd ("Ensus"). The contract which they entered into provided that SCL was to procure a performance bond but that once an Acceptance Certificate was issued by Ensus to SCL, the performance bond would become "null and void".
SCL duly procured a performance bond from a bank. Disputes arose between the parties as a result of alleged defects at the plant. Nevertheless, an Acceptance Certificate was issued and shortly after its issue Ensus sought payment under the performance bond. SCL argued that the performance bond had become null and void and therefore sought an interim injunction restraining Ensus from making any demand under the bond.
Ensus argued that English jurisprudence over the years has established that a call on an on demand bond can be restrained only if there is fraud. SCL countered that there was no reason why the court could not and should not restrain any breach of contract by way of injunction in the ordinary way and fraud was not the only ground for a restraining injunction.
Akenhead J reviewed the relevant caselaw authorities and drew the following principles from them:
- Fraud is not the only ground upon which a call on a bond can be restrained by injunction.
- There is no legal authority permitting a beneficiary to make a call on the bond when it is expressly disentitled from doing so.
- In principle, if the underlying contract (in relation to which the bond has been provided by way of security) clearly and expressly prevents the beneficiary from making a demand under the bond, it can be restrained by the court.
- The court will be able to determine the issue finally at trial. The position is different at the interim injunction stage because the court can only very rarely form a final view as to what the contract means. However, given the importance of bonds in the commercial world, it would be necessary for the court at this early stage to be satisfied that the applicant has a strong case.
Akenhead J also opined that, where a beneficiary seeks payment in circumstances where the underlying contract clearly and expressly prevents it from doing so, this is a second type of exception (in addition to the fraud exception) preventing a beneficiary from making such a demand. In other words, this situation is not another example of fraud.
On the facts of the case, the judge formed the clear view (at the very least at this stage) that SCL had established a strong case that, as between it and Ensus, the bond was to be treated as null and void. This was because the contract clearly provided that the bond would become null and void upon issue of the Acceptance Certificate. Although "as a matter of commercial common sense and practice" the bond remained valid on its face and as between Ensus and the bank, they must treat it as "null and void" and Ensus must return it to SCL. Ensus had no right to call on it thereafter.
Accordingly, SCL was entitled to the injunction.
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.
