UK: On Demand Bonds: A Strategic Retreat?

Last Updated: 21 August 2015
Article by Claire King

An On Demand Bond1 is as an unconditional undertaking to pay a specified amount to a named beneficiary, usually on demand and sometimes on the presentation of certain specified documents2. In other words, Big Bank promises to pay Mr Employer Łx immediately, and without hesitation or further investigation, on presentation of the correct documents (normally a certificate) to him, completed in the way specified on the face of the On Demand Bond. The contract to pay out in these circumstances is directly with Big Bank and Mr Employer. (Big Bank will have a separate agreement with Mr Contractor to ensure he doesn't end up out of pocket).

Historically, under English Law, the only circumstances in which the courts would prevent a call on an On Demand Bond once it has been made, and monies being paid out, were "when there is a clear fraud of which the bank has notice."3 This was a hard test to satisfy.

In 2011 and 2013, two TCC cases on the issue of whether calls on On Demand Bonds could be restrained via injunction seemed to indicate that the Courts may be moving away from such a rigid adherence to these principles and, arguably, closer to the more relaxed position in other jurisdictions (for example, in Singapore where the notion of "unconscionability" has developed)4.

In Simon Carves -v- Ensus5, the contract provided that the bond was to become null and void upon the issue of an Acceptance Certificate, save in respect of pending or previous claims. An Acceptance Certificate had been issued, but a dispute arose as to whether any claims were pending or had been previously notified by the time of its issue. Simon Carves then sought an injunction restraining a call being made on the Bond, and later, requiring the beneficiary to withdraw a call that had been made in the meantime. Akenhead J stated that, if the underlying contract in relation to which the Bond had provided by way of security, clearly and expressly prevented the beneficiary from making a demand under the Bond, then the beneficiary could be restrained by the court from making such a demand. In his view, there was no legal authority permitting a call on a bond when it is expressly disentitled from doing so and, in his view, the party seeking the injunction had a "strong case" that the call was not a permitted one.

In the case of Doosan Babcock –v- Comercializadora de Equipos6 ("MABE"), (Mr Justice Edwards-Stuart) used the principles set out by Akenhead J in Simon Carves v Ensus, to grant an injunction restraining calls on two On Demand type Bonds issued in respect of a Brazilian Power Plan contract. Again, the Judge assessed the merits of the right to make the call under the underlying contract in order to reach his decision. In Mr Justice Edwards- Stewart's view, Doosan Babcock had a strong case that the Employer's refusal to issue a Taking Over Certificate for various units was a breach of contract and that it was only as a result of that breach that the Employer was in a position to make the call on the On Demand Bond in question.

Mr Justice Edwards-Stuart noted that Akenhead J was concerned with whether or not there had been a breach of the underlying contract, had decided (on a non-binding basis) that there was a strong case there had been one, and then applied the American Cyanamid principles7 which apply to injunctions generally. Indeed, he explained that:

"I accept that this decision has extended the law, but in my view it is done so adopting a principled and incremental approach that does not undermine the general principles applicable to interim injunctions to restrain a party making call under a bond". [Emphasis added]

Has this "principled and incremental approach" been followed and accepted since 2013? The answer appears to be "no".

In Mr Justice Stewart-Smith's judgment, (MW High Tech Projects UK Ltd –v- Biffa Waste Services Ltd)8, of February 2015, a retreat seems to be indicated back to the strict fraud test outlined above. In that case, the contractor sought to argue that the call on a Retention Bond was invalid. The ground relied on was that the claim made on a Parent Company Guarantee (which was expressed to be a condition precedent before any call on the Bond could be made within the underlying construction contract) was not a valid one in that the claim made under it was disputed. As such, it could not be regarded as a claim under the Parent Company Guarantee for the purposes of calling the Retention Bond.

Mr Justice Stewart-Smith refused to get involved in the dispute between the parties under the underlying contract in question. Instead, he relied heavily on a non-construction Court of Appeal case in 2014 (Wuhan Guoyu Logistics Group Company Limited & Another –v- Emporiki Bank of Greece SA (No. 2))9 in which the principle of autonomy was re-emphasised. In that case, Mr Tomlinson J had stated:

"21... The rationale for this well understood and well hallowed approach is that the guarantee is intended to be an autonomous contract, independent of disputes between the seller and buyer as to their relative entitlements pursuant to the different contract between themselves..."

It was also noted by Mr Justice Stewart-Smith that, by the time the Wuhan case had reached the Court of Appeal, it had been established in separate arbitral proceedings that the basis of the call was contractually unjustifiable and that decision was final and finding. Despite that (i.e. despite the fact the call on the bond was unjustifiable and unjustifiable under the underlying contract), the Court of Appeal held that the beneficiary was entitled to summary judgment upon his call upon the Bond.

Mr Justice Stewart-Smith noted:

"It seems to me, both on the principle and authority that the only established acceptance to the rule that the court will not intervene should be where there is a seriously arguable case of fraud, or it has been clearly established that the beneficiary is precluded from making a call by the terms of the contract."

He did not consider it was sufficient that:

"There is a seriously arguable case that the beneficiary was not entitled to draw down. It must be positively established that he was not entitled to draw down under the underlying contract".

He therefore rejected that the seemingly less vigorous test found in Simon Carves and Doosan Babcock.

Conclusion

For now then, it looks as if the apparent extension to the fraud exception in Doosan Babcock and Simon Carves is in retreat. If parties do provide On Demand Bonds, they should be very aware that they will face real difficulties in restraining a call on that bond if one is made.

Parties offering (or having no choice but to offer) On Demand Bonds that are subject to English law, should also check the underlying contract to ensure that there is a clear and express duty on the beneficiary to account for any excess proceeds from a bond call under the underlying Construction Contract, including damages by way of direct costs and indirect costs (such as the bank charging a higher fee for future bonds) or caused by the damage to reputation that can often accompany a call on such a bond. While some standard forms do provide for this, others do not and, where there is an entire agreement clause, the implied duty of account may be excluded10.


Footnotes

1. Also commonly referred to as Performance Bonds, Unconditional Guarantees, Performance Guarantees and/ or Demand Guarantees

2. Geraldine Andrews QC and Richard Millett QC, Law of Guarantees, London, Thomson: Sweet & Maxwell 5th Edition, 2008, Chapter 16 – 001, page 575

3. As per Lord Denning in Edward Owen Engineering Limited -v- Barclays Bank International [1978] 1 All ER 976 (CA)

4. See for example Raymond Construction Pte Ltd v Low Yang Tong [1996] SGHC 136, in which Lai Kew Chai J stated that the "concept of 'unconscionability' to me involves unfairness, as distinct from dishonesty or fraud, or conduct of a kind so reprehensible or lacking in good faith that a court of conscience would either restrain the party or refuse to assist the party."

5. [2011] BLR 340

6. y Materiales Mabe Limitada [2013] EWHC  3201 (TCC)

7. See American Cyanamid Co (No 1) v Ethicon Ltd [1975] UKHL 1 (05 February 1975) in which the test for whether an interim injunction should be granted was stated to be: (1) Whether the claimant had a strong or merely an arguable case; (2) The adequacy of damages as a remedy; (3) The balance of convenience; and (4) Whether the status quo should be maintained.

8. [2015] EWHC 949 (TCC)

9. 2013 EWCA (CIV) 1679

10. See Cargill International SA v Bangladesh Sugar and Food Industries Corp [1996] 4 All ER 563 (QBD)

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