UK: Performance Guarantees

Last Updated: 27 February 2009
Article by Edward Davis and Sue Millar

In Permasteelisa Japan KK v (1) Bouyguesstroi (2) Banca Intesa SPA [2007] EWHC 3508 (QB) the Court declined to continue an injunction in relation to a performance guarantee in circumstances where no case of fraud had been made out and there was only a seriously arguable case that there had been a breach of the contractual requirements which formed the preconditions to the call of the bond.

The claim concerned a construction project in Sakhalin, Russia. Bouyguesstroi ("B") were engaged to construct office facilities and buildings. B subcontracted the curtain wall works to Permasteelisa Japan KK ("P") via an arrangement contained in three documents all of which were executed on 19 February 2004. One of those documents was a subcontract, under which P was required to procure a performance bond ("the Bond"). The Bond was issued by Banca Intesa SPA ("the Bank") on 13 June

2004 in the sum of US$463,666, subject to potential adjustment in two circumstances:

(1) adjustment at the request of B in the event of any increase of the subcontract price so that the amount of the guarantee would always be equal to 10% of the subcontract price; and

(2) on receipt of a turnover notice of the subcontract works issued and signed by B for the whole subcontracted works ("the Turnover Notice"), the amount of the guarantee should be reduced to an amount equal to 5% of the subcontract price.

Disputes subsequently arose between P and B following delays in the project which led to both parties claiming substantial costs from the other. On 3 September 2007 B wrote to the Bank requesting payment of the Bond to an account B had opened in Russia. The subcontract contained an arbitration clause, but in view of the urgency of the matter, on 28 September 2007 P commenced interim proceedings against B and the Bank, seeking to restrain the Bank from paying the Bond to B. P was granted an injunction by the Court against B (but not against the Bank) until the return date. On the return date, P requested a continuation of the injunction.

P relied on the following grounds in support of the continuation of the injunction:

(1) the call on the Bond by B was not based upon a default under the subcontract, which it submitted was a condition precedent for such a call;

(2) the contractual requirements under the clause of the subcontract which applied in the case of a default leading to a call had not been complied with; and

(3) the Turnover Notice was due and was withheld by B and therefore B could not make a call on the Bond for the full amount as the sum should be reduced to 5% of the contract sum.

Accordingly, P submitted that it had a seriously arguable case that B was not entitled to call the Bond. B countered this submission by arguing that as the Bond was a performance bond, the Court should not grant an injunction to prevent a call on the Bond unless it was satisfied that a seriously arguable case of fraud had been established.

The Judge stated that whilst he considered that P had a seriously arguable case in relation to B's failure to comply with the necessary contractual procedure under the subcontract, he did not consider that there was any arguable case that B's conduct in calling the Bond amounted to conduct sufficient to draw the inference of fraud so as to justify the intervention of the Court on that ground.

The Judge held:

(1) That, whilst a Court might grant an injunction where there is an express term restricting the circumstances in which a party can draw on a letter of credit or performance bond and where it is positively established that the party was not entitled to draw down, the same will not apply where there is only a serious arguable case to that effect. Otherwise, the commercial effectiveness of letters of credit and performance bonds would be eroded.

(2) Accordingly, applying those principles, the Court should not intervene in this case as (a) no case of fraud had been made out and there was only a seriously arguable case that there had been a breach of the contractual requirements under the sub-contract which formed preconditions to the call of the Bond, and (b) this was not a case where a freezing injunction should be granted against the funds as B had not established a serious risk of dissipation. The injunctions were therefore discharged.

Practical implications

Although this decision is not surprising it is a helpful reminder of the Court's approach to allegations of fraud in the context of performance bonds. The Court found in this case that the commercial effectiveness of performance bonds should take priority in these circumstances. Accordingly, an injunction to prevent a beneficiary calling on a bond will only be granted (or continued) where there is either a seriously arguable case of fraud or more than a seriously arguable case that the beneficiary was not entitled to call on the bond.

This article was originally written for Stephenson Harwood's quarterly publication, Finance Litigation Legal Eye. If you would like to receive this publication, please contact Stephenson Harwood.

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.

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